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«Making good use of Market Timing on stock markets»

’Market timing’ is the decision to disinvest or invest in the stock markets at the right time. To achieve such an objective, Investors must base theirs expectations on a combination of fundamental and technical analysis. Explanations ...

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The historical recession of 2008 and the ongoing economic recovery have strongly reintroduced the concept of volatility in investors’ minds, yet an essential concept of the stock markets mechanism. The application of several basic rules - heavily and rightly mentionned - can avoid "saloon doors" on stocks markets: portfolio diversification, exposure reduction according to market environment, use of hedging instruments. But these may be useless without the right timing!

’Market timing’ is the decision to disinvest or invest in the stock markets at the right time, based on price expectations. To achieve a winning choice, we obviously need accurate expectations.

On one hand, fundamental analysis allows to anticipate major market moves over the long term through a series of leading economic indicators easy to use, such as the ISM Manufacturing of the U.S: based on conditions and forecasts of thirty industries, it foreshadows quite accurately the state of equity markets. On the other hand, technical analysis provides a short-term vision of the buying and selling forces in the markets. By reading prices and identifying graphics, it highlights potential entry or exit points in the market, price targets and pivot points of trend changes. It therefore improves the momentum of market operations.

Finally, one of the basic rule of market timing relies on a clear arithmetic rule: get 1/3 of bear market and 2 / 3 of bull market are enough to generate significant gains over the long-term. Illustration with the history data of the DJ EuroStoxx 50. By avoiding the five largest declining sessions, an investor "A " who invested 100 euros at the index creation in early January 1987, has its invesment valued at 498 euros in February 22, 2011. Better, It would have been valued at 696 euros by avoiding the ten largest declining sessions. For comparison, the investment of an investor "B" who held investment over the entire period is valued only at 331 euros. Of course, the risk is to miss strong bullish sessions (cf. Graphe 1). By being out of the market during the five largest gains sessions, an investor "C" gets 207 euros. And only 148 euros being out for the top 10 sessions (cf. Graphe 2). To generate performances and stand out from the market, it is necessary to practice active management based on fundamental and technical approaches, in order to find entry and exit points.

Be careful, however, this strategy can be risky if the investor’s beliefs are initially based on inaccurate expectations. "To Feel" the key moments is obviously not easy, the instinct must be thwarted by analysis!

David Kalfon , March 2011

Article also available in : English EN | français FR

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