When it Comes to Investing, What is Market Timing? It’s More Important to Short-Term Investors than Long-Term Investors, and Here’s Why.
They say “timing is everything,” but does that really apply to investing? It depends on whether you’re in it for the long game or the short game. What is market timing? By using market timing strategies, you can identify the best times to buy and sell a stock, thereby maximizing your profits. Market timing may not be everything, but it is a big thing for short-term investors.
If the long term is your investment timeline, you probably won’t care much about pullbacks or volatility. When stocks get knocked back for a few months, you’re OK with it. You’re betting that prices will be higher a year from now, five years from now, and 10 years from now. They usually are.
If that’s the case, then market timing may not matter to you. You might be fine buying stocks regardless of what’s going on in the market.
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The Romance of Market Timing
Finding a great growth stock and getting in on the ground floor can be like finding romance. It’s full of intangibles and mystery. It can be exciting, with even your greatest expectations exceeded. And pleasant surprises just keep on coming, often convincing you that the good times will never end.
Where do we find this romance? It’s usually concentrated in the market highfliers (including some of our Cabot Growth Investor recommendations). Thousands of investors simply cannot understand why certain young growth stocks soar month after month to astronomical valuation levels for no apparent reason. Often, these stocks have growing sales but no earnings. The product or service may not be well understood by the masses. And yet, the stock continues to advance past everyone’s wildest expectations. “What does he see in her?” you might wonder.
An old Wall Street adage, one that we’ve found as useful as any, explains this phenomenon: A stock, like love, thrives on romance and dies on statistics. There are plenty of investors out there who are able to understand the long-term potential for the aforementioned growth companies. These investors see something exceptional and even revolutionary that other investors miss, and are willing to buy and hold onto the stock, even at prices that appear to be completely unreasonable and unjustifiable to other investors.
It isn’t until much later that the romance fades. At this time, the mystery and sexy expectations are replaced by cold, hard facts. This reality, even though it may be exceptional, seldom matches the dream. Reality, in fact, tends to suggest limitations. And that’s when the early investors usually jump ship, pushing the stock down and ending its run to record heights.
So how does all this help you make money? Our studies over the years have convinced us that you can make a great deal of money from a stock in its romance phase, before most investors realize the full thrust of the company’s story. If you wait for reality and a slew of fundamental facts (like growing earnings and a knockout of all competitors) to pour in, chances are you’re too late; the stock has already factored in the great news you’re now reading.
Our advice is to look for exciting growth stocks that are presently in their romance phase. Once invested, your job is to exit your position at the end of the stock’s romance phase, when, frankly, all of the news is usually excellent. The fundamental facts will begin to support the stock’s lofty price, and investor sentiment regarding the company will be outstanding. However, you’ll notice the stock price and the relative performance (RP) line gradually eroding, unable to reach new highs. (Relative performance measures the stock’s performance relative to the market as a whole—see Lesson 5.) Over a period of weeks, if the RP line falters, you’ll know the romance has ended, and reality is taking over. At this point, you’ll want to sell the stock and look for your next love affair.
How to Predict a Downturn with Market Timing Indicators
What few people write about is the most important thing to investors—specifically, is there any way to see a downturn coming and to avoid the pain, and can that be applied to future meltdowns?
The answer is yes, and the method for avoiding devastating declines isn’t as complicated as the media makes it out to be.
The method: trend following, and specifically our Cabot Trend Lines (which tell us the market’s longer-term trend) and Cabot Tides (intermediate-term). It has nothing to do with the dollar, oil prices, interest rates or (thank Heaven) politics—instead, it’s all about determining which way the market is headed, and staying in gear with that.
The Trend Lines average about one signal per year, though it can be far fewer. It’s probably our most reliable (and simple) market timing indicator. In fact, if you had theoretically bought the Nasdaq at every buy signal during the past 18 years and went to cash during sell signals (which you should be doing now), you’d have nearly doubled the Nasdaq’s return (253% to 135%)!
Our Cabot Tides generate an average of three to five signals per year, but again it varies depending on the environment. When both of these trend-following measures are combined with the action of leading stocks, it gives you a real-time picture of the market’s health—no opinions, no guesses, no forecasts, just facts.
So you might wonder, what do our market timing indicators portend? Well, remember, they’re trend following measures, not trend predictors (to make big money you simply have to stay on the right side of the major trends), but we have gone back to look at all Cabot Trend Lines sell signals since 2000.
Basically, 60% of the time, the Nasdaq saw at least another leg down of 6% to 8% during the next month or two, with some falling much farther than that. The other 40% of the time, the signals didn’t lead to a ton more selling, with the market finding at least short-term support and rebounding for a few weeks.
Mike Cintolo uses Cabot’s market timing indicators to analyze stocks in Cabot Growth Investor and Cabot Top Ten Trader.
Do you now know the answer to, “what is marketing timing”? What other questions do you have that we can answer in the comments below?
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