MARKET TIMING With all the debate surrounding the effectiveness of market timing, often the underlying goals of the strategy are forgotten. The principle of market timing is to avoid capital commitments during periods when returns are expected to be subpar and to invest during those times when returns are expected to be above average. Those who complain that they would forgo all of the market's return by missing the 10 best days of the year fail to mention that they would get slaughtered if they were fully invested on the 10 worst days of the year. During an epic bull market such as the 1998-2000 run, detractors will complain that market timing doesn't work and that you should be long and strong. These arguments miss the point. The reason to use market timing is not to outperform during raging bull markets or to be invested during the best 10 days of the year. There are two reasons to use market timing:
Sentimental Journey
It's In The Sentimentby Ajay Jani
1. To maximize return on investment by repeatedly turning over your capital in short-term trades. A small edge compounded can add up to a solid rate of return.One myth regarding market-timing is that it is as difficult to perform as catching the proverbial falling knife. Many methodologies, including moving average crossovers and Donchian breakouts, seek to put money to work when trends are strong and asset prices are moving up. I would argue that most market-timing methodologies tend to be trend-following and chase strength in asset prices.
2. To protect your hard-earned assets during a crunching bear market that can knock 25-50% off the market. By avoiding these debilitating drawdowns, you have the ability to make fresh commitments of capital when fear is rampant, prices are low, and opportunity beckons.However, for those of you who prefer to purchase securities when prices are beaten down, a systematic sentiment model might be just the tool you need to help time your investments.
HOW YA FEELING NOW?
Sentiment is measured to determine when the crowd is overly bullish or bearish. The logic is that when everyone has moved to one side of the market, little cash is left to continue driving prices in the current direction and a correction is due. There are a variety of sentiment indicators, ranging from the Market Vane Bullish Consensus and put/call ratios, all the way to mutual fund cash levels. These all seek to measure the current state of affairs relative to previous market environments to determine where the crowd stands.
One notable feature of sentiment models is that they are the antithesis of trend-following, thus suitable for those investors who prefer to sell into euphoria or buy into panic. The systematic sentiment model presented here adheres to this idea of buying during market breaks.
...Continued in the August issue of Technical Analysis of STOCKS & COMMODITIES
Excerpted from an article originally published in the August 2006 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2006, Technical Analysis, Inc.
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