Why Stock Market Timing

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Stock market timing can reduce your risk and amplify your gains by avoiding bear market losses.

stock market timing, timing the stock market, market timing

Copyright 2006 Equitrend, Inc.

It’s important that you understand the impact that a bear market has on your capital. The give and take of your investment capital is not equal. If you placed $100 into an investment and it declined 50% to $50, what is the rate of return you would need to earn back your original investment of $100?

Once you lose money, it takes a much greater return on the funds you have left to recapture your original investment. In this case, you would need a 100% gain on the remaining $50 to recapture your original $100 investment.

Looking at historical bear markets in the United States, we can conclude that the time to recovery from a bear market can take between six months and twenty five years! Declines in portfolio value have ranged from 20% to 86.7%! Not a good scenario for buy and hold investors. This is why you would be better off financially to never lose money in any one year and to only achieve half of the market’s returns in the positive years. Let us explain how this is possible. If you never lost money in the down market years, you would only need to capture 38.33% of the gains in the positive market years to equal a buy-and-hold position in the Nasdaq 100 index. More realistically, if your losses in the down market years were half the Nasdaq’s losses, you would only need to capture 63.37% of the Nasdaq’s gains in the positive market years to equal a buy-and-hold position.

The point we are making is that you don’t need to equal or outperform the performance of the market in the positive market years if you protect your capital in the down market years. Protecting your capital in the down market years has an exponential effect on growing your capital over time.

The objective of any stock market timing strategy should be to reduce risk and maximize returns – with risk reduction being the most important factor. All other things being equal, you want to invest in the least volatile, highest reward, lowest risk strategy possible.

You may be reading this today because you are tired of giving all of your own assets, or your client’s assets, away to a bear market. You may even be in the position where your retirement has been diminished to the point of having to change your retirement plans.

Whatever the reason, there are better ways to grow and protect your assets than the buy and hold (buy and hope) myth promoted by Wall Street.

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Beating the S&P 500 with Stock Market Timing

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Investors can beat the S&P 500 using stock market timing. Most mutual funds can’t.
stock market timing, market timing, timing the stock market, investments
Copyright 2006 Equitrend, Inc.

Approximately 75% of fund managers do not beat the S&P 500 year in and year out. How can a basket of 500 hundred stocks beat the majority of actively managed mutual funds? The people who manage these funds are, for the most part, brilliant people. They are highly educated and have access to the most advanced information and decision support systems in the world. So why is it that they do not outperform the S&P 500?

A Quick Test:

Here’s a very crude test of management performance: Let’s compare the domestic-equity mutual fund performance supplied by Morningstar against the S&P 500 index for one, three, five and ten-year periods, looking back from April 30, 1995. The S&P 500 index is a fair comparison for large, domestic companies.

Our results:

–Of the 1,097 funds Morningstar covered for the one-year period, 110 beat the S&P 500, while 987 fell short. Results ranged from 46.84% to -32.26%, while the S&P 500 attained a 17.44% return.

–During the three-year period, the S&P 500 returned 10.54%, while results in the funds varied from 29.28% to -15.02% compounded annually. Of the total 609 funds, only 266 beat the S&P 500.

–Shifting to the five-year period, of 470 funds, 204 beat the S&P 500. Results ranged from 27.35% to -8.51%, while the index racked up 12.62%.

–At ten years, only 56 of 262 funds managed to beat the index, and results varied from 24.77% to -4.06% compounded annually against 14.78% for the S&P 500.

The fact that most funds do not beat the overall stock market should not be surprising. Since the majority of money invested in the stock market comes from mutual funds, it would be mathematically impossible for the majority all of these funds to out perform the market.

The implied promise held out to investors in actively managed mutual funds is that in exchange for higher fees (relative to index funds), the actively managed fund will deliver superior market performance. There are a host of barriers to fulfilling this implied promise.

Some of the problems are:

–The larger a mutual fund gets, the more difficult it becomes to deliver exceptional performance.

–Although fund size runs counter to performance, fund managers have a strong motivation to let the fund grow as big as possible because the bigger the fund gets, the more money the fund managers make.

–Most skillful mutual fund managers are hired away by hedge funds, where their financial rewards are greater and there are few restrictions on investment techniques.

–By law mutual funds are supposed to be conservative, which in theory limits their potential losses. This conservative stance generally limits their ability to use arbitrage, options, or shorting stocks.

Can You Do Better?

Because of the general inflexibility and restrictions of most mutual funds, your investment capital is not properly hedged against market fluctuations. In most cases, if you compared the beta of the equity exposure held in actively managed mutual funds to an equal equity exposure to the S&P 500 index, your reward/risk ratio would be less rewarding than purchasing an identical equity exposure to the S&P 500 index. So, the answer is, you can do better and beat the S & P 500 by using an effective stock market timing system.

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How To Evaluate a Good Stock Market Timing System

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How to evaluate a good stock market timing system to enhance your investment returns.
stock market timing, timing the market, market timing, investment
Copyright 2006 Equitrend, Inc.

No matter what investment discipline you use, there are three important variables for measuring your success – peak-to-valley drawdown, beta, reward/risk ratio. The first and most important factor is your measure of risk. Performance volatility is a measure of the variability of an investment’s rate of return.

Specifically, it is the standard deviation of the sample set of monthly returns that have been observed for the investment over the interval being considered. A simple way to measure a good stock market timing system is to calculate the largest peak-to-valley drawdown that has or would have occurred in the last five years. This drawdown is your measure of risk.

Second, is your beta to the overall market. Beta is an important variable that measures portfolio or timing system volatility as compared to an index. Most Betas are calculated based on the S&P 500 index. A beta of one tells you that the system has the same volatility (i.e. risk) as the S&P 500 index. A beta of two tells you that the system has twice the volatility as the S&P 500 index.

By actively managing your money, your stock market timing system should allow you to reduce the beta of your portfolio as compared to the index you are trading and substantially improve your returns over time.

Third, is your reward/risk ratio, which calculates your reward as compared to your risk. In order to calculate this, you need to know your average rate of return. A rule of thumb is that your return should be at least twice as large as your risk. For example, if your largest peak-to-valley drawdown percentage over the last five years is 15%, your average rate of return should be at least 30%. In other words, your reward/risk ratio (30%/15% = 2) should be 2 or greater.

The best stock market timing system for you will depend a lot on your personality, specifically your tolerance for risk. You might think a trend timing system that averages 80% is a great system, but what if I told you that system had a risk potential of 35%?

Most people cannot tolerate a system that decreases their investment capital more than 20%. Your tolerance and ability to accept risk should help you identify a stock market timing system that right for you.

There are only a few systems available that really work. Most come and go like mayflies on a warm summer day. When evaluating a timing system, it important to consider all of the above factors plus whether or not the system has survived and prospered over at least a five year period. If they’ve made it through the last five to six years, you’ve likely found a good stock market timing system.

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Active Stock Market Timing

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Active Stock Market Timing discusses the merits and pitfalls of stock market timing.
stock market timing, timing the stock market, market timing
Copyright 2006 Equitrend, Inc.

Much has been written about the virtues and dangers of active stock market trading, or “market timing.?
Most of the pundits and so called “experts” will tell you that stock market timing doesn’t work, that it’s dangerous, and that “buy and hold” is the best and only way to invest.

But this conventional wisdom is patently untrue. Here are the facts based on my research and extensive real time experience.

If you want to be a successful stock market timer, you need three key elements:

1. A system that actually works.

2. Discipline to follow the system.

3. Patience to stick with the system long enough to make it work for you.

And it tough to do all three.

Here why:

Most market timing systems don’t work. Or don’t work consistently enough to be valid. Some will work in trending markets but get slaughtered during flat times. Most systems don’t work in all markets.

Investors lack the discipline to follow a proven system. Once an investor finds a viable program, he or she needs the discipline to follow it. Sadly, some either can’t or won’t do that. When they let their own judgment or intuitions interfere, they don’t get the results they want or could have enjoyed by simply following the buy and sell signals they receive.

Investors lack the patience to stick with their system. Many investors are constantly in search of the Holy Grail, a program that never loses a trade. The fact is, no method will win every trade, and investors without patience will find themselves hopping from advisor to advisor with no rewards to show for their efforts.

However, there are a number of proven systems available that recognize these pitfalls and successfully time the market to massive profits year after year. Anything you hear or read to the contrary is simply not true. Wall Street has a vested interest in opposing stock market timing because it is a threat to their very existence.

Investors have two choices. They can pursue the conventional wisdom of buy and hold and hope for the best, or the modern investor can educate himself and find a timing system with which he is comfortable to protect and grow his wealth. There are a number of proven options available, but the absolute worst thing one can do is listen to the pundits who tell you that “stock market timing” doesn’t work.

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