Market Timing - Does It Work?

By: Sol Palha | Wed, Oct 28, 2015
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Anything I've ever done that ultimately was worthwhile... initially scared me to death. ~ Betty Bender

Many individuals and experts state that market timing is impossible. The answer to this question is yes and no. We all know there are seasons in a year and we know roughly when winter, summer, fall, and spring will begin. No one can predict the exact time the one season will transition into the next. The same rationale applies to market timing. If you are trying to predict the exact market turning points, then you might get it right once or twice, but overall your record will be dismal, it is an exercise in futility for the most part and best reserved for those who seem to have a deep desire to take on large losses. Market timing is like waiting for a change in the season. Everyone, in general, knows when winter, fall, spring or summer will roughly begin. However, no one can predict the exact date summer will transition into fall. The same methodology can be applied to timing the markets. Instead of trying to identify the precise Market top or bottom, we look for signs of bottoming and topping action in the market, which would correlate to spotting changes in the weather. This data in turn facilitates the process of determining how close one season is from transitioning to the next. Adopting this approach makes market timing a distinct and achievable feat.

Researchers have demonstrated that humans are no better than monkey's when it comes to managing money (Kahneman, Santos et al.).

Perhaps the first thing for humans to learn would be simple money management skills. After all, you cannot run without learning to crawl and walk.

Kahneman asserts in his book, Thinking Fast & Slow that monkeys with dart board are actually better than humans trying to manage money on wall street.

Some interesting quotes from his book.

"People who spend their time, and earn their living, studying a particular topic produce poorer predictions than dart-throwing monkeys who would have distributed their choices evenly over the options."

"The idea that the future is unpredictable is undermined every day by the ease with which the past is explained...Our tendency to construct and believe coherent narratives of the past makes it difficult for us to accept the limits of our forecasting ability. Everything makes sense in hindsight; a fact financial pundits exploit every evening as they offer convincing accounts of the day's events. And we cannot suppress the powerful intuition that what makes sense in hindsight today was predictable yesterday. The illusion that we understand the past fosters overconfidence in our ability to predict the future."

In general, we tend to agree with what he has to say, and it's, for this reason, we hardly listen to the talking heads. When one understands that the markets are nothing but a cesspool of emotions, the importance of understanding the mass mindset takes on a new meaning. The most important tool in our opinion is mass psychology as it can help one pinpoint the emotional state of the masses. The focus should be on identifying what the masses are doing or going to do, and only then should the technical structure of the markets be examined. It is the masses that drive the markets and not the markets that drive the masses. Understaning what the masses are doing is therefore imperative if one hopes to succeed in the markets. History clearly indicates that the masses are always on the wrong side of the equation as they either get in too late, or overstay their welcome.

It is the change in the herd mentality that dictates what the market does. The reason most fail is because they do things backward, they try to treat the market as a separate entity and try to find out what it is doing and then determine what the crowd will do. When in fact, what they should be doing is looking at the crowd and then using the information to determine how the market will react. It is the crowd that drives the market. A market soars to new highs or crashes to new lows because of the way the masses are interpreting the situation. How can you predict something if you are not looking at the source? Human beings are the most illogical of all animals. Despite having the power of reason and logic, they are the only creatures on this planet that will go out of their way to make sure they are in harm's way.

Technical analysis is useful in spotting the symptoms of the disease, but it does not identify the cause. To identify the cause, one needs to deal with the main driving force behind the market; emotions are the main driving forces in the market.

If we had to choose between TA and Mass psychology, we would choose mass psychology. There is no standalone tool more powerful than understanding Mass behavioral patterns, at least as far as we are concerned. But we do not have to choose as we have the option of combining the best elements of TA with Mass Psychology. Take time to understand the mass mindset; we feel that is probably the most important piece of knowledge when it comes to investing and trading.

To answer the question, we believe that market timing does work when applied in the manner described. As long as you are not trying to identify the exact top or bottom, then timing the markets is a distinct possibility. Putting the most basic tenets of mass psychology to use, one could have easily sidestepped the dot.com bubble, the housing bubble, etc., and at the same time one could have jumped into the markets when everyone was panicking, examples are the crash of 1987, 2003, 2007, etc., On each of these occasions, the sentiment was either euphoric or extremely bearish. When sentiment moves to the extreme zones, it is time to step out and wait for things to cool. Would you have got out right at the top or opened positions at the precise bottom. The answer is a resounding no. However, you would have walked away with solid profits and would have had the opportunity to purchase quality stocks at rock bottom prices. Be wary when the crowd is ecstatic and ecstatic when the crowd panics.

 


Tactical Investor, where mass psychology and technical analysis converge seamlessly

 


 

Sol Palha

Author: Sol Palha

Sol Palha
TacticalInvestor.com

Sol Palha is a market analyst and educator who uses Mass Psychology, Technical Analysis and Esoteric Cycles to keep you on the right side of the market. He and his partners are on the web at www.tacticalinvestor.com.

The information contained herein is deemed reliable but no guarantee is made about its completeness or accuracy. The reader accepts this information on the condition that errors or omissions shall not be made the basis for any claim, demand or cause for action. Any statements non-factual in nature constitute only current opinions, which are subject to change. The author/publisher may or may not have a position in the securities and/or options relating thereto, & may make purchases and/or sales of these securities relating thereto from time to time in the open market or otherwise. Neither the information, nor opinions expressed, shall be construed as a solicitation to buy or sell any stock, futures or options contract mentioned herein. The author/publisher of this letter is not a qualified financial advisor & is not acting as such in this publication. Investors are urged to obtain the advice of a qualified financial & investment advisor before entering any financial transaction.

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