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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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He noticed that favorable periods for stocks lasted between four months and eight months, and so he either stretches or limits his investment season depending on the MACDSolution to Mistake #3: Know When the Odds of Investment Success Are in Your Favor ON MARCH 7, 2004, THERE WAS AN INTERESTING ARTICLE IN THE Wall Street Journal written by Andrew Blackman, Market Timing Is All in the Approach. The following is a portion of this article. Conventional wisdom warns against the dubious practice of playing your hunches to get in and out of the stock market at opportune times. And rightly so. Most of the time this is a recipe for getting burned. But there are less risky kinds of market timing that follow basic formulas and can produce better returns than following gut instincts or, say, the traditional buy-and-hold strategy. The idea is that since bear markets come around every three or four years, a prudent investor should have a strategy to deal with them, instead of just holding all the way to the bottom. So unabashed market timers have devised systems to help them anticipate and avoid some of the worst market plunges, protecting their capital by staying in cash through the bad times. Some of these systems are fairly simple to follow, and involve just a few trades a year in index funds. Here, then, are unconventional timing techniques that could help you stay out of the market at most of the worst times and get back in so you benefit from most up ticks. These are not fail-proof, and they cannot predict the markets future direction. But they might help you make better investment decisions. If you want to use them, you should use exchange-traded index funds, which allow you to trade as often as you like, unlike mutual funds. Just be sure to go through a discount broker to minimize fees. Minimize bear-market damage: Buy-and-hold investing is often cited as the best way to achieve long-term wealth. Indeed, it is a good strategy that produces solid returns over time. But there are two problems. Sure, the market does fully recover over time. The losses suffered by those sticking it out to the bitter end of a bear market, however, can take ages to recoup. The NASDAQ Composite has made an impressive 84% comeback since its bear-market low on October 9, 2002. Yet the index is still 59% below its level in March 2000. The other problem is that many investors who consider themselves buy-and-hold types are nothing of the kind. According to a 2002 survey by the Investment Company Institute and the Securities Industry Association, 86% of individual investors say they practice buy and hold. Yet consulting firm Dalbar found that between 1984 and 2002, equity mutual-fund investors held their funds for an average of 21/ 2 years and got an annual return of 2.6%, well be low the 12.2% return for the Standard & Poors 500 stock index in the same period, and even below inflation. This is not buy-and-hold investing. Instead, it is buy high, sell low investing. So given that most of us do in fact try to time the markets in our own way, and that so many of us are doing such a bad job of it, why not use a system that at least has a better track record? Watch the calendar: You can often beat buy-and-hold by using an indicator as simple as a calendar. Since 1950, the Dow has returned 12.9% annually for the six months between November and April, compared with 4.4% between May and October and 7.7% for the year as a whole, according to Leslie Masonson, author of All About Market Timing. So simply buying an index fund November 1 and then transferring to cash on April 30 can improve your returns while reducing risk by keeping you out of the market for half the year. You would have missed, for example, the stock market crash of October 19, 1987, the 1,370-point drop in the Dow in September 2001, and the 1,651-point decline in the third quarter of 2002. On the other hand, you would also have missed the stock market gains of last summer. No system works all the time. But over the long run, the record is impressive. Follow the election cycle: Presidents tend to give a boost to the economy in the second half of their first term, just in time for their re-election bids. So markets tend to languish in the first couple of years, shoot up in the third year, and be fairly strong in the election year. Between 1901 and 2003, the Dow gained on average 12.5% in pre-election years, 9.3% in election years, 5.2% in post-election years, and 3.2% in midterm years. The Bush administration has so far been a textbook case: losses in the first two years, and a big gain in the pre-election year. Try a technical approach: For those who are willing to dabble in more complex strategies, the best approach may be to look for professional help. When evaluating different market-timing firms, be wary of outrageous claims nobody can predict the market or guarantee future returns. And check long-term track recordsreal-world results count for a lot more than back-tested data. But you dont need an advanced economic degree to use some technical strategies. One option, for example, is to use moving averages. The 200-day moving average simply means the average level of the index over the past 200 days. It is a more long-term measure of the direction of the market than its price on any given day. So market timers often see an index crossing its moving average to the upside as a buy signal, and crossing to the downside as a sell signal. Using shorter periods, such as a 50-day or 20day moving average, can give quicker indications of when the market is turning, but also are more volatile and so can be harder to read. Take a seasonal view: You can combine different systems to get the best results. Sy Harding, publisher of the newsletter Street Smart Report, has refined the best six months strategy by using an indicator based on moving averages to provide a more exact buy or sell signal. He noticed that favorable periods for stocks lasted between four months and eight months, and so he either stretches or limits his investment season depending on the MACD, or moving average convergence divergence. The key in all of this is to do your research and choose a system you feel comfortable with. Check out free charting services to see how the system would have worked in the past. Then you could maybe try it with a small portion of your savings first, to see how it works in the future. Dont shy away if the system seems to tell you the opposite of what all the experts are saying. As good contrarian investors know, the best time to buy usually is when the herd is screaming, Sell! The preceding article is well written and succinct. Clearly, your ability to make money in the stock market is in direct proportion to your ability to invest only when the odds are with you. In other words, when in doubt, stay out. I remember, when I was a stockbroker, having a client who was a professional horseracing gambler. I always tried to get to know my biggest clients personally and since he had a seven-figure account with me, I invited him to a dinner party at my house. After dinner, I suggested we go to the racetrack. He agreed but cautioned me that I might be disappointed. I did not ask what he meant, but I soon found out. The following Saturday we were at Calder Racetrack in Miami, Florida. I bet every race, and of course, lost. My client however never made a bet. I asked him how he could just sit and watch the races without betting. He told me that he would never bet on a race unless he liked a horse and the odds to win were at least 3 to 1. All the horses he liked were at lesser odds so he passed. I was amazed and yet somewhat ashamed that I did not have his discipline. The following weekend, he made four bets (out of nine possible) and won three, giving him a substantial return on his money. Many racetrack old-timers have said, You can beat a race, but you cant beat the races. I strongly believe it is the same for the stock market. You can win in the stock market, but if you are always invested, the next bear market can wipe you out. Clearly, you need to consider some use of timing. Making your bets or investments at certain times when the odds are in your favor makes a lot of sense to me and I hope to you as well. When is it a good time to invest in the stock market? To answer that question, we need to understand some dynamics that pertain to the stock market at various times of the year. Timing the Stock Market for Success First Quarter 401 (k) investments401(k) pension plans and IRA in vestments must be made before April 15 of each year; otherwise the IRS will disallow them. Since the tax year ends on December 31 for individuals, most of their money flows into these plans in the first quarter of each year. A large percentage are invested in public mutual funds, such as those owned and run by Fidelity Investments and Alliance Capital. Public mutual fundsMost money managers of public mutual funds have to be fully invested at all times. This is due to the popularity of fund of funds managers who raise money for mutual funds but insist that they be fully invested. Fund of funds managers diversify and spread risk by putting money into various mutual funds that have differing investment styles. Since most mutual fund money managers have to be fully invested at all times, 401(k) and IRA money put into mutual funds forces these money managers to buy stocks until the money inflows dry up. It makes sense to avoid buying into the demand for stocks created by the huge sums of money invested in IRAs and 401(k)s in the first quarter. When this flow of money is fully invested, usually by the end of April, the market usually drops as demand dries up. Fourth Quarter Institutional tax loss sellingIndividuals have until De cember 31 of each year to offset losses with gains. Many investors are unaware that the mutual fund industry must balance gains and losses by October 31 of each year. This creates an artificial supply for stocks in the September-October period each year as the mutual fund money managers sell their losers to offset capital gains they had during the year. Clearly, you will have a better probability of success in buying stocks in the fourth quarter of each year as sell-offs occur for reasons other than the companys fundamentals. When the institutional tax loss selling ends on October 31, the stock market will usually rise, as the pressure on many stocks is gone. Let us look at some facts. Since 1957, 57 percent of all market tops have occurred in February-April and 77 percent of all bottoms took place in October-December. In 1986, when the mutual fund industrys tax year changed to October 31, cycle predictability got even better. Since 1986, 67 percent of all market tops have occurred in the first quarter and 86 percent of all market bottoms took place in October-December. Clearly, if you were to focus on buy programs in the fourth quarter each year, your chances for success would improve dramatically. We now have all the pieces necessary to become consistent winners in the stock market. We have a strategy. We know whom to follow and not follow, and we know that there are certain times to invest that have a higher probability for success than others. It is now time to talk about insider trading. After all, insiders are The Vital Few, and we need to understand the rules governing their behavior, how to use them, and where to go to get an accurate assessment of what they are doing in the stock market at any given time. It is also useful for me to discuss some of my experiences, how they led me to discover the value of insider behavior, and my thought process as to how I developed my ideas for using the media to my advantage. |
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