Part 1: Market Timing – The Long and Short of It

  • May 31, 2017

    Market-ChartThis seven-part series discusses market timing from the perspective of an ordinary investor. The series focuses on equity-market timing – although much of the content could be applied to other markets such as bonds, real estate and commodities. This first part of the series discusses long term market timing vs. short term market timing.

    Most market timing strategies are based on efforts to identify when a market or security is more likely to trend in the same direction or revert back towards a previous level. A security is said to be trending when an upward movement is more likely to be followed by another upward movement and conversely when a decline is more likely to be followed by another decline. A security is said to be mean-reverting or simply reverting when a see-saw pattern is more likely as the security alternates between upward movements and downward movements.

    I am often asked whether I believe that the U.S. stock market trends or reverts. My answer is “Yes” – because I believe that the market both trends and reverts at the same time! How can that be? The answer is that it depends on the time horizon. Over short periods of time the market often is trending while over quite long periods of time it is reverting. I believe that there are numerous time horizons with different tendencies. So, for example, a market may be trending on a daily, monthly and quarterly basis while at the same time mean-reverting on a trade-by-trade and annual basis. High frequency trading firms look for patterns lasting less than a second, while individual investors might only adjust their portfolio risk exposures occasionally in efforts to time the market.

    The nemesis of a market timing strategy is a random walk – where the next price movement of a security is independent of its previous price movements. And even if market prices are not priced efficiently enough to generate a true random walk, the prices might be close enough to their true values to prevent market timing strategies from being successful once commissions and other trading costs are included.

    The next part in this series discusses short-term market timing – which from the perspective of ordinary investors is daily. The remaining installments discuss longer-term market timing. In this context, long-term market timing refers to the adjustment of portfolio risk exposures periodically to bring the portfolio to a risk exposure that is either deemed to be more appropriate for the investor’s risk tolerance or for the investor’s market view.

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