A fool and his money
A fool and his money will soon be invited everywhere: The folly of market timing
Dr. Tejinder Singh Rawal
tsrawal@tsrawal.com
There is a way to make a lot of money in the market; unfortunately it is the same way to lose a lot of money in the market.
Peter Passell and Leonard Rose
The share market continues to surprise all. In recent past it has surprised even the most optimistic bull operators by giving a better than expected return. Invariably every person I come across asks a question, "What's the market going to do next? How high (or low) will it go?". I feel this question is not relevant. The relevant question ought to be: “What does my long term investment strategy call for in present market conditions?”
It is every investor’s dream to get in the market when the market is low and sell when it is high. People employ all kind of strategies to find where the market would be tomorrow or the next month. A successful market timer does not have to do much homework since market timing alone delivers handsome returns for him, which makes him confident of his own strategy. This payoff to timing the market makes him an easy victim for the next market-timing strategy.
Market timers have a wide range of tools available at their disposal. Some of them are apparently spurious; others may give an impression of an exact science. Some people consider macroeconomic variables – like interest rates and GDP growth- to predict that you must buy shares when interest rates are low. While low interest does lead to higher economic growth, it may fail to lead to higher share prices if the growth was less than what was anticipated by the market. Some people would use the feel good indicators (opinion of the experts on CNBC, speech of the Finance Minister, and RBI Governor), while some rely on the opinion of cocktail party chatters! I even came across an economic model built trying to predict the stock market direction on the basis of the prevailing trend in the hemline of women’s skirts!( Believe me, there is a theory called Hemline Effect Theory to be found in Financial management). The argument is that, rising hemline denotes boldness and fashion consciousness which comes from confidence that you get from a buoyant economy, and is an indicator of a stronger market, while increasing length of the skirts denotes a conservative and cautious approach!
Market timing refers to an attempt to time investing decisions so as to invest in assets which are expected to go up in the near term and divest from assets which are expected to go down in the near term. The simplest implementation may be to shift one's assets between cash and stocks generically in order to take advantage of anticipated stock market movements. Market timers are the ultimate “buy low and sell high” traders. Day traders, who move in and out of positions in minutes or hours, are the extreme market timers. They look for small profits each day by capitalising on swings in a stock’s price.
I strongly advice against market timing in its various forms. Many a time when you try to time the market you end up doing a reverse timing, and you end up buying when you should be selling, and selling when you should be buying. It is `time in' the market and not `timing' the market that is important. The long-term stock investor prospers because he owns shares in businesses that are a part of one of the fastest growing economies in the world. The important thing is not so much when you buy, but that you buy and continue to buy and hold.
A great strategy in a volatile market could be what is called a rupee-cost averaging. The strategy is to invest a fixed sum of money periodically, say every month, over a long period of time in fundamentally strong shares. This evens out fluctuations arising out of short term ‘noise’ and long term trade cycles. To start with you may identify a basket of , say, 10 scripts. You keep investing a fixed amount in this basket, for a period of five years. An example will clarify the approach. Suppose you invest Rs. 2000 every month in Reliance Industries (RIL) shares over a period of 5 years. When the price of RIL was Rs. 500, you bought 4 shares, when the price fell down to Rs. 400 you bought 5 shares, when it shot up to 800, you could buy only 2 shares ( and utilise balance Rs. 400 in buying another share from your basket) . If next month should the price fall to 600, you would automatically up your investment in the company. The obvious advantage of this strategy is that you are automatically buying more shares when the market falls and fewer shares when the market rises. This automated strategy could be more suitable for the investors who do not have the time or the expertise in identifying value buys. The strategy, these days popularly called Systematic Investment Plan (SIP) could also be utilised by passive investors for buying Mutual Funds over a period of time.
Economist William F. Sharpe, wrote in an article, "Likely Gains from Market Timing," in Financial Analysts Journal "... unless a manager can predict whether the market will be good or bad each year with considerable accuracy, (e.g., be right at least seven times out of ten), he probably should avoid attempts to time the market altogether." If a Noble laureate like Sharpe could not make money by timing the market, since he knows that he cannot be right at least seven times out of ten, needless to say, market timing is a strategy to be avoided by investors.
"The long, sad history of market timing is clear: Virtually nobody gets it right even half the time. And the cost of getting it wrong wipes out the occasional gain of getting it right. So the average investor's experience with market timing is costly. Remember, every time you decide to get out of the market (or get in), the investors you buy from and sell to are the best of the big professionals. (Of course, they're not always right, but how confident are you that you will be 'more right' more often than they will be?) …Charles Ellis, Winning the Loser's Game. What is more, every time you get out of or in a share, you may brokerage, and also pay short term capital gains tax of 10% on the profits booked.
Looking back at market history, there have been far fewer successful market timers than successful stock selectors, and it is not clear whether even the few successes that can be attributed to market timing are more attributable to luck. Why is it so difficult to succeed at market timing? First, it is not possible to predict the future. Market is the sum total of the behaviour of the individual players. While at times market may behave rationally, more often that not it does not do so. It is the rational behaviour that alone can be the base for the science of prediction. Fitting something that does not behave rationally to a scientific straightkacket can lead to disastrous consequences. A far better solution is: not to be bothered about the direction of the market, but to approach the investment using a bottom-up approach. Identify a fundamentally strong script, which is trading at a price lower than its value, thereby giving you a comfortable margin of safety, and invest in such stock. You are likely to come across such stocks in all market conditions, bullish as well bearish. And if you don’t find any such investment, it would be a prudent decision to sit on cash, rather than invest. Warren Buffett’s investment vehicle, Berkshire Hathaway is known to be sitting on a large pool of cash when it cannot find safe investment opportunities.
Put the watch down, and relax, you can't time the market. Invest whenever you are ready. A wise investor is patient, disciplined, and focused on long-term goals.
(The author is an eminent Chartered Accountant. He invites comments at tsrawal@gmail.com )
Dr. Tejinder Singh Rawal
tsrawal@tsrawal.com
There is a way to make a lot of money in the market; unfortunately it is the same way to lose a lot of money in the market.
Peter Passell and Leonard Rose
The share market continues to surprise all. In recent past it has surprised even the most optimistic bull operators by giving a better than expected return. Invariably every person I come across asks a question, "What's the market going to do next? How high (or low) will it go?". I feel this question is not relevant. The relevant question ought to be: “What does my long term investment strategy call for in present market conditions?”
It is every investor’s dream to get in the market when the market is low and sell when it is high. People employ all kind of strategies to find where the market would be tomorrow or the next month. A successful market timer does not have to do much homework since market timing alone delivers handsome returns for him, which makes him confident of his own strategy. This payoff to timing the market makes him an easy victim for the next market-timing strategy.
Market timers have a wide range of tools available at their disposal. Some of them are apparently spurious; others may give an impression of an exact science. Some people consider macroeconomic variables – like interest rates and GDP growth- to predict that you must buy shares when interest rates are low. While low interest does lead to higher economic growth, it may fail to lead to higher share prices if the growth was less than what was anticipated by the market. Some people would use the feel good indicators (opinion of the experts on CNBC, speech of the Finance Minister, and RBI Governor), while some rely on the opinion of cocktail party chatters! I even came across an economic model built trying to predict the stock market direction on the basis of the prevailing trend in the hemline of women’s skirts!( Believe me, there is a theory called Hemline Effect Theory to be found in Financial management). The argument is that, rising hemline denotes boldness and fashion consciousness which comes from confidence that you get from a buoyant economy, and is an indicator of a stronger market, while increasing length of the skirts denotes a conservative and cautious approach!
Market timing refers to an attempt to time investing decisions so as to invest in assets which are expected to go up in the near term and divest from assets which are expected to go down in the near term. The simplest implementation may be to shift one's assets between cash and stocks generically in order to take advantage of anticipated stock market movements. Market timers are the ultimate “buy low and sell high” traders. Day traders, who move in and out of positions in minutes or hours, are the extreme market timers. They look for small profits each day by capitalising on swings in a stock’s price.
I strongly advice against market timing in its various forms. Many a time when you try to time the market you end up doing a reverse timing, and you end up buying when you should be selling, and selling when you should be buying. It is `time in' the market and not `timing' the market that is important. The long-term stock investor prospers because he owns shares in businesses that are a part of one of the fastest growing economies in the world. The important thing is not so much when you buy, but that you buy and continue to buy and hold.
A great strategy in a volatile market could be what is called a rupee-cost averaging. The strategy is to invest a fixed sum of money periodically, say every month, over a long period of time in fundamentally strong shares. This evens out fluctuations arising out of short term ‘noise’ and long term trade cycles. To start with you may identify a basket of , say, 10 scripts. You keep investing a fixed amount in this basket, for a period of five years. An example will clarify the approach. Suppose you invest Rs. 2000 every month in Reliance Industries (RIL) shares over a period of 5 years. When the price of RIL was Rs. 500, you bought 4 shares, when the price fell down to Rs. 400 you bought 5 shares, when it shot up to 800, you could buy only 2 shares ( and utilise balance Rs. 400 in buying another share from your basket) . If next month should the price fall to 600, you would automatically up your investment in the company. The obvious advantage of this strategy is that you are automatically buying more shares when the market falls and fewer shares when the market rises. This automated strategy could be more suitable for the investors who do not have the time or the expertise in identifying value buys. The strategy, these days popularly called Systematic Investment Plan (SIP) could also be utilised by passive investors for buying Mutual Funds over a period of time.
Economist William F. Sharpe, wrote in an article, "Likely Gains from Market Timing," in Financial Analysts Journal "... unless a manager can predict whether the market will be good or bad each year with considerable accuracy, (e.g., be right at least seven times out of ten), he probably should avoid attempts to time the market altogether." If a Noble laureate like Sharpe could not make money by timing the market, since he knows that he cannot be right at least seven times out of ten, needless to say, market timing is a strategy to be avoided by investors.
"The long, sad history of market timing is clear: Virtually nobody gets it right even half the time. And the cost of getting it wrong wipes out the occasional gain of getting it right. So the average investor's experience with market timing is costly. Remember, every time you decide to get out of the market (or get in), the investors you buy from and sell to are the best of the big professionals. (Of course, they're not always right, but how confident are you that you will be 'more right' more often than they will be?) …Charles Ellis, Winning the Loser's Game. What is more, every time you get out of or in a share, you may brokerage, and also pay short term capital gains tax of 10% on the profits booked.
Looking back at market history, there have been far fewer successful market timers than successful stock selectors, and it is not clear whether even the few successes that can be attributed to market timing are more attributable to luck. Why is it so difficult to succeed at market timing? First, it is not possible to predict the future. Market is the sum total of the behaviour of the individual players. While at times market may behave rationally, more often that not it does not do so. It is the rational behaviour that alone can be the base for the science of prediction. Fitting something that does not behave rationally to a scientific straightkacket can lead to disastrous consequences. A far better solution is: not to be bothered about the direction of the market, but to approach the investment using a bottom-up approach. Identify a fundamentally strong script, which is trading at a price lower than its value, thereby giving you a comfortable margin of safety, and invest in such stock. You are likely to come across such stocks in all market conditions, bullish as well bearish. And if you don’t find any such investment, it would be a prudent decision to sit on cash, rather than invest. Warren Buffett’s investment vehicle, Berkshire Hathaway is known to be sitting on a large pool of cash when it cannot find safe investment opportunities.
Put the watch down, and relax, you can't time the market. Invest whenever you are ready. A wise investor is patient, disciplined, and focused on long-term goals.
(The author is an eminent Chartered Accountant. He invites comments at tsrawal@gmail.com )
posted by Dr. Tejinder Singh Rawal at 11:55 pm
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