Market Timing Is A Mindset — So Is Failing To Practice It

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Buy-and-Holders don’t just disdain market timing. They have promoted a false description of what it is. Most investors properly have a negative reaction to the false image. So they reject the market timing concept without ever having actually examined it in a realistic way.

What It Means To Practice Market Timing

If you asked most investors what it means to practice market timing, they would say that it means taking guesses as to when stock prices will move up or down and changing your stock allocation to profit from those changes. It sounds silly. It sounds like a parlor game. People think of investing as a serious business. So this idea has little appeal.

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But is that really market timing?

It is one form of market timing. But it is indeed a silly form. There is a good bit of evidence that this silly form of market timing does not work. But then why should it? Is there any reason to believe that a particular investor would possess special knowledge as to when stock prices would move in one direction or the other? This silly form of market timing is a guessing game. Unless the guesses are based on solid information, it doesn’t make much sense to go down this path.

But showing that the guessing-game approach to market timing doesn’t work is not at all the same as showing that market timing in general doesn’t work.

Market timing is price discipline. The long-term value proposition of stocks changes with shifts in the CAPE value. Investors who want to maintain the same risk profile over time are required to adjust their stock allocation to do so. That’s a form of market timing that makes complete sense. There are no guessing games involved. The sensible approach to market timing is just an attempt to manage risk.

The silly approach to market timing is a one-shot endeavor. One changes one’s stock allocation and then one changes it back. The market timing transactions are separate from all of one’s other investment activities. It’s not that way at all with the sensible approach to market timing. The purpose of this form of market timing is to maintain a constant risk profile. Managing risk is core to the investment project. So this form of market timing is integrated with all of one’s other investment decisions.

Say that stock prices crash. A market timer is going to view a crash very differently than a non-market-timer. A non-market-timer does not possess much understanding of why stock prices sometimes collapse suddenly and violently. The best explanation that a Buy-and-Holder could offer is that something must have gone haywire in the economy. Since a Buy-and-Holder does not understand why so much of the value of his portfolio has disappeared into nothingness, he is likely to experience feelings of panic in the face of a price crash.

A market timer would respond very differently. The purpose of market timing is to keep risk constant. So a market timer would have been aware that a price crash had become likely before it arrived. He would be aware that valuations had gotten out of hand and that it is high valuations that cause price crashes. So there would be no feelings of panic. Quite to the contrary. The market timer would be going with a lower stock allocation at the time prices collapsed. So he would lose less money in the crash. And he would be acutely aware that the lower prices brought on by the price crash presented an opportunity to invest in stocks at a time when their long-term value proposition was much stronger.

Market timing is a mindset. So is failing to practice it.

A Mindset

The mindset that a market timer brings to the stock investing project is an aware mindset. Valuations are the most important stock investing reality. It is out-of-control valuations that cause bull markets and it is the inevitable restoration of reasonable valuation levels that cause bear markets. The market timer is always watching to see how emotional investors have become because his money is at risk and investor emotion determines price movements.

It’s different for a Buy-and-Holder (a non-market-timer). Buy-and-Holders tell themselves that all price changes are determined by economic developments. So they view investor emotion as irrelevant. In fact, that’s why they disdain market timing. If we had always known that valuations affect long-term returns, there never would have been a Buy-and-Hold strategy. The strategy is the product of the once-widespread belief that the market is efficient. If the market were efficient, overvaluation would be impossible and market timing would be pointless. I mean no insult to my Buy-and-Hold friends but price indifferent strategies encourage a willful ignorance of the most important issue in stock investing.

The purpose of any purchase is to obtain the thing being purchased at the best possible price. If anyone suggested that it is a good idea to ignore price when purchasing cars or cereal or blankets, no one would take that person seriously. The amazing reality, however, is that the conventional wisdom today is that it is okay to ignore price in only one market – the stock market.

That’s the mindset. I view it as a dangerous mindset, I believe that the best way to purchase stocks is to become as aware as possible of the pros and cons of all purchases. And of course the pros and cons change with changes in stock valuations. To become successful stock investors, we all need to develop the market timing mindset.

Rob’s bio is here.

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