In order to grasp the importance of market timing, one must first differentiate the concept from its bogus counterpart, market forecasting.
The purpose of this article is to define the two subjects and then explain why an efficient market timing model should be the centerpiece of any trading or investment strategy.
Forecasting involves the use of some economic or technical meter to discern where the market will be trading on a future date.
Frequently this practice involves little more than guesswork, hope, and dream.
Historical market forecasters live in infamy, usually after a disastrously bad call. Joe Granville, the notorious ‘bear’ known for his extravagant predictions, saw little upside to the Dow Jones Industrial Average in the 1990s when it was around 4500.
Abby Joseph Cohen, partner, and Senior U.S investment strategist at Goldman Sachs, predicted the S&P 500 would reach 1,675 in 2008. By November of that year, the index had traded as low as 741. She was soon replaced by David Kostin as a chief forecaster.
Apparently, they still believe the notion of forecasting has merit.
Conversely, the practice of market timing utilizes historical precedent and probability.
Price patterns and trend strategies found in recurring market cycles are combined to form relative predictive models.
The model is probabilistic and offers a greater likelihood of one thing happening over another. The market or stock will either rise or fall.
No effort is made to predict exactly where, when, or how profitable the trend will be.
A risk management strategy is employed to limit downside risk should the model produce an unprofitable signal.
Winners are considerably larger and statistically outnumber losses or the model is not viable and offers little predictive value.
Market timing methods can be deceptively simple and alarmingly accurate. Risk management tools are paramount and the entire strategy is planned and tactical.
Your Certified Financial Planner will tell you that the market rises more years than it falls.
He’ll also neglect to mention how long you might want to hang on to a catastrophic loss.
In stark contrast, a reputable advisory will provide detailed entry and exit prices as well as maximum risk percentages.
More importantly, it will offer statistical probabilities and historical performance records.
Market timing has been in use for as long as market participants have been searching for statistical edges.
Japanese candlestick charting can be traced to the early 1700s when rice merchants developed the system to gain a trading advantage in the Ojima Rice market.
Today, micro processing facilitates the organization and management of massive amounts of market data.
Institutional market timing models reflect this in size and complexity. However, consistent use of a simple, effective system is still the best strategy.
The smart money seldom enters and exits the market randomly, without a sound trading plan. You shouldn’t either.
Give market timing its due to achieve consistent profitability. And let the forecasters continue to entertain us.