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The Realities of Timing the Market (Redux)
Old 01-24-2009, 07:16 AM   #1
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The Realities of Timing the Market (Redux)

I accidentially posted this in the "Life After FIRE Fourm"--thought it was more appropriate to be here.

From Jason Zweig's Column in the 1/24/09 Wall Street Journal:

"History shows that the vast majority of the time, the stock market does next to nothing. Then, when no one expects it, the market delivers a giant gain or loss -- and promptly lapses back into its usual stupor. Javier Estrada, a finance professor at IESE Business School in Barcelona, Spain, has studied the daily returns of the Dow Jones Industrial Average back to 1900. I asked him to extend his research through the end of 2008. Prof. Estrada found that if you took away the 10 best days, two-thirds of the cumulative gains produced by the Dow over the past 109 years would disappear. Conversely, had you sidestepped the market's 10 worst days, you would have tripled the actual return of the Dow.

"Although we could make a bundle of money if we could accurately predict those good and bad days," says Prof. Estrada, "the sad truth is that we're very, very unlikely to do that." The moments that made all the difference were just 0.03% of history: 10 days out of 29,694."

I thought this was pretty remarkable.
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Old 01-24-2009, 09:09 AM   #2
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I don't believe this. All the research I've read shows that the majority of the gains from the stock market over long periods of time were due to reinvested dividends, which makes sense to me. You're getting a piece of a revenue stream. It's a more modern idea that you buy stocks only for appreciation (or depreciation!)

I would guess that his study is flawed because it looks only at capital gains and losses.

EDIT: OK, on second reading I guess he's not trying to say how to invest in the market for return, but that if you are investing for pure capital gains, big changes don't happen very often, which is fine.
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Old 01-24-2009, 09:13 AM   #3
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I have seen similar discussions/statistics for many years. However, until a few months ago, the only ones presented were one-sided....only the idea that missing out on the up days would kill you. I guess that was to encourage you to stay in the market.
I had never seen the opposite stats until a few months ago.....the idea that avoiding a few big down days would help a lot.

In principle it would seem that if your luck is random you would be equally likely to benefit/lose by trying to time the market. I don't know why most presentations are biased.......do they know that human nature will bias your decisions to lose? Or do they have something to gain by putting/keeping you in the market?

But,yes, quite remarkable statistics.
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Old 01-24-2009, 10:25 AM   #4
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Very interesting. A conclusion then would be that if in fact the few up (or down) extraordinary days account for the bulk of the capital gains/losses then market timers should do just about as well as buy and holders on average. Most souces present as fact that market timers don't do as well as buy and holders.
Why the disconnect? is it just becasuse of dividend reinvestment?
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Old 01-24-2009, 10:27 AM   #5
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Very interesting. A conclusion then would be that if in fact the few up (or down) extraordinary days account for the bulk of the capital gains/losses then market timers should do just about as well as buy and holders on average. Most souces present as fact that market timers don't do as well as buy and holders.
Why the disconnect? is it just becasuse of dividend reinvestment?
Yes.
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Old 01-24-2009, 10:49 AM   #6
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This is simply using mathmatics to confuse investors. In any market you may see a pattern of down 3 percent up 4 percent down 4 percent up 6 percent down 4 percent and the market trends no where then a steady move up to end the year with a gain of 10 percent. The mathmatician states " hey if you missed the two biggest days you would not have earned anything for the year, which is true but most of the time the biggest days happen when volitility is at it's highest and gains are made from the long term trends and the dividends. Look at any long term chart and see if you see daily spikes accounting for yearly gains.
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Old 01-24-2009, 11:13 AM   #7
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Yes, the holy grail of investing, called day trading. One who masters this will end up owning the entire world equity.

Mere mortals like us can only cope along, trying to get the longer multi-year business cycle, using mundane and boring tools like asset allocation and rebalancing.
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Old 01-24-2009, 11:39 AM   #8
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I've also heard this story told over and over, usually with different numbers of days and years. Now it's 10 days out of 109 years!

It's like saying "If you had only missed Pearl Harbor, you would have totally avoided WW-II!" Or "if you had slept through July 21, 1969, you would have missed the entire space race!"

I'm sure that, in retrospect, there are days when it would have been wonderful to have been all-in or all-out, but basically it's useless data mining.
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Old 01-24-2009, 01:18 PM   #9
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I'm sure that, in retrospect, there are days when it would have been wonderful to have been all-in or all-out, but basically it's useless data mining.
I agree it is not particularly useful, but I do think it is interesting. Usually I've seen this type of data presented as a lead-in to some market timing/"technical analysis"/astrology scheme to help you identify the impending great or terrible day. "All you have to do is avoid the very few days when the market registers big declines, and our program shows you how to do that." Since the article at the link in the OP doesn't pretend to be able to predict these days, I think it is okay. The study just points out that markets move abruptly. That's a useful nugget in a world where people are always telling me they can ride the trends to fabulous wealth by hopping on and off at the right time.
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Old 01-24-2009, 01:47 PM   #10
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The study just points out that markets move abruptly. That's a useful nugget in a world where people are always telling me they can ride the trends to fabulous wealth by hopping on and off at the right time.
I think the first point is that they can move exceptionally abruptly over the space of a day, not that they don't move significantly over longer periods (I don't buy the "next to nothing" quote in the article). The dot-com bubble and its crash was not the result of two or three days of extraordinary movement, after all. And heck, there's easily 10 days in the last few months that I wish I could have timed, never mind 10 days out of the last 109 years.

You are right, the over-all message is that trying to time the market is a fool's errand.
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Old 01-24-2009, 03:09 PM   #11
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I think the first point is that they can move exceptionally abruptly over the space of a day, not that they don't move significantly over longer periods (I don't buy the "next to nothing" quote in the article). The dot-com bubble and its crash was not the result of two or three days of extraordinary movement, after all. And heck, there's easily 10 days in the last few months that I wish I could have timed, never mind 10 days out of the last 109 years.

You are right, the over-all message is that trying to time the market is a fool's errand.
This is what I have always understood the point of the stories to be, specifically favoring regular investments that are then held long-term, and urging investors not to panic and get out when the market drops. Investors who do so, and only get back into the market when it appears to have turned the corner, are likely to miss the small number of days that have big upswings, after already having suffered the impact of the big drop, and that's a formula for slower growth, or even shrinkage, of the portfolio.
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Old 01-24-2009, 03:22 PM   #12
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This is what I have always understood the point of the stories to be, specifically favoring regular investments that are then held long-term, and urging investors not to panic and get out when the market drops. Investors who do so, and only get back into the market when it appears to have turned the corner, are likely to miss the small number of days that have big upswings, after already having suffered the impact of the big drop, and that's a formula for slower growth, or even shrinkage, of the portfolio.
I believe this is true as stated. But it is not really an argument against market timing; more an argument against unskilled market timing. One can never be sure where a market is going in the near or intermediae term. But if market reversion is reality, and if capitalism is to work, it must be a reality. then if might be helpful to be relatively light when valuations are extended, and relatively heavy when they are compressed. One who does this will still experience big down days, and miss some huge blow-off gains such as 1999, but overall he should beat buy and hold.

From reading this board over the last 6 months, I think that emotionally this tends to be very hard, and therefore many people once hurt by a big drop (a drop that my methods would not have predicted) will move away from equities, waiting to "see the horns of the bull". The hard part is that in some cases this may be wise, so we are back to do you follow a rote plan, or listen to voices, get gut feelings, etc. The funny part is that guys such as Soros claim to go on gut feelings, and I do not doubt that for them it works. For most of us these feelings are simply dictated by whatever has happened recently, so will tend to be counterproductive.

Ha
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Old 01-24-2009, 04:32 PM   #13
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(snip)You are right, the over-all message is that trying to time the market is a fool's errand.
This is what I have always understood the point of the stories to be, specifically favoring regular investments that are then held long-term, and urging investors not to panic and get out when the market drops. Investors who do so, and only get back into the market when it appears to have turned the corner, are likely to miss the small number of days that have big upswings, after already having suffered the impact of the big drop, and that's a formula for slower growth, or even shrinkage, of the portfolio.
I believe this is true as stated. But it is not really an argument against market timing; more an argument against unskilled market timing. One can never be sure where a market is going in the near or intermediae term. But if market reversion is reality, and if capitalism is to work, it must be a reality. then if might be helpful to be relatively light when valuations are extended, and relatively heavy when they are compressed. One who does this will still experience big down days, and miss some huge blow-off gains such as 1999, but overall he should beat buy and hold.

From reading this board over the last 6 months, I think that emotionally this tends to be very hard, and therefore many people once hurt by a big drop (a drop that my methods would not have predicted) will move away from equities, waiting to "see the horns of the bull". The hard part is that in some cases this may be wise, so we are back to do you follow a rote plan, or listen to voices, get gut feelings, etc. The funny part is that guys such as Soros claim to go on gut feelings, and I do not doubt that for them it works. For most of us these feelings are simply dictated by whatever has happened recently, so will tend to be counterproductive.

Ha
I think that stories relating to the ten days of largest gain are mainly told by people who do not believe in the existence of market timing which is not "unskilled". I would have to have counted myself among that camp up until recently. After having read Yes, You Can Time the Market I now wonder whether this is in fact the case. Messrs Stein & DeMuth back tested their method over various markets for both small regular purchases and larger one-time investments with generally positive results. However, the method they propose uses a long-term rolling average. Its intent, if I understand it, is to enable the investor to determine whether the market is priced high or low at this time, and to buy—or not—according to the results. It is a buy-low-and-hold method. I do not think they claim that it will reveal when the market is likely to drop at some near-future date, and I definitely recall that the method did not make any appreciable difference in one's eventual outcome unless the purchases are held at least ten years, and is not intended to be applied to individual stocks but to indexes. I need to read it again, because I do not recall what recommendations, if any, they had about selling the appreciated stocks later on when it comes time to live on the proceeds of one's investments. I also don't recall whether the method has any relevance for people who intend to live on the income generated by stocks rather than on the capital gains. I suppose there must be an index of dividend-producing stocks, and one could use the book's principles with that as easily as with the S&P (which is what they used for the examples in the book). But I don't think the book included any information on how the method would affect an income-producing portfolio, or of whether if applies to the bond market also.
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Old 01-24-2009, 04:44 PM   #14
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... it might be helpful to be relatively light when valuations are extended, and relatively heavy when they are compressed...
I am with you on this. I did change from 75% equities in 2007 to 50% equities in mid 2008, and also posted my action.

I am not bragging, because the stocks that I believed in and owned had high beta, therefore I did not fare better than some passive investors like unclemick, who has the same loss from the top as I do, as reported in another thread.

In a recent interview, when Soros was asked how he was still active in the market though already having more money than needed, he replied something to the effect that he wanted to see if he could really understand reality, meaning making short-term predictions to the unfolding events.

I still have fun fooling around with my positions, as I have said, and not being rich but foolhardy, still holding out some hope of beating the market by a few percent.

When I am tired of it, will go "psst... Wellesley".
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