Market Timing: Should You Attempt It?

http://library.northernlight.com/PN19991...

Top 80. Jul 9, 2001 7:49 AM

» Kirk - Warren Buffett is NOT a market timer

This is a VERY good story about Warren Buffett as he spends a great deal of time on "reasonable expectations for the market".

Notice that he makes a specific point that he is NOT a market timer...

Investors in stocks these days are expecting far too much, and I'm going to explain why. That will inevitably set me to talking about the general stock market, a subject I'm usually unwilling to discuss. But I want to make one thing clear going in: Though I will be talking about the level of the market, I will not be predicting its next moves. At Berkshire we focus almost exclusively on the valuations of individual companies, looking only to a very limited extent at the valuation of the overall market. Even then, valuing the market has nothing to do with where it's going to go next week or next month or next year, a line of thought we never get into. The fact is that markets behave in ways, sometimes for a very long stretch, that are not linked to value. Sooner or later, though, value counts. So what I am going to be saying--assuming it's correct--will have implications for the long-term results to be realized by American stockholders.

Hard to argue when he says so in his own words.

Very good article BTW.

-- posted by Kirk

Top 81. Jul 18, 2001 7:04 AM

» Kirk - Fourier Theory

In response to message posted by JIMMY62:

Listening to the BB show is a weakness of mine. The advice is now suspect or nonexistent, so what is the fascination?
Anticipation of the caller who says, "Can I ask another question?" is the thing. When he hears those dreaded words BB knows immediately that the screener has been beaten yet again. I imagine BB having a flash of emotions (panic, then anger, then resignation) as he gulps and says, "Yes, go ahead."

This week the second question I heard was about the timing model. The caller asked, Are the indicator weighted in the timing model? BB said that in the timing model the indicators are weighted, and offered nothing more. Delighted, I imagine to get off so lightly from a caller inclined to probe for solid data.

Funny post! Can you imagine living life that way? Afraid of your shadow because of what embarrassing questions it might ask to expose you to the light of day?

For a while I have thought that the timing model was pure fiction. This answer, if true, tells that there is a timing model.

Oh, I am sure there is a timing model. My guess is it is a sheet of paper with the indicators listed and the weighting factors where he updates it on Mondays where he probably used to update the indicators by hand then see what the total says. Perhaps it gives an output between 0 and 100 and over 70 is "Change to Bull" and under 30 is "Change to bear" and then once these levels are hit, he uses "hysteresis" to keep "the model" in the bull or bear mode until the other trip level is crossed. That would explain how he is still at 65% cash even though most of the indicators have improved, they probably have not improved enough to cross the trip level.

As I've written before, I've done a TON of modeling and ANYTHING in the past can be modeled with the "Fourier Transform". See this site for a simple explanation of how it works http://aurora.phys.utk.edu/~forrest/pape...
The Fourer transform fits the past really well if you have enough variables... the problem is predicting the future is nearly impossible as ANY new variable not in the original model can cause the output to literally explode meaning some minor new "indicator" can cause the model to go haywire. It could cause an auxiliary timing model to say "Buy QQQ at $86" right before QQQ drops to $33.40. This actually happens... people use the transform to design filters. The filters work really well between two frequency windows but the output blows up once you go outside that window (equivalent to predicting the future).

Anyway, bottom line is anyone that REALLY has modeling experience will tell you that a "timing model" is doomed to failure once an unanticipated indicator shows up... I think it has been referred to in the past as an "exogenous event". To use Brinker's recommendation to buy QQQ in the $80's in October 2000 right before they dropped to $33.40 the "exogenous event" was the election mess where Al Gore won the popular vote and GW Bush won the electoral vote, but it took the Supreme Court to decide how to count the votes.

Thankfully for Brinker, most in the US can't even do the math to understand Fourier Theory much less understand the implications. Thus they are easy suckers for the idea of a "timing model that can predict the future".

-- posted by Kirk

Top 82. Jul 18, 2001 7:13 AM

» mdorsey - Re: Warren Buffett is NOT a market timer

In response to message posted by Kirk:

Me thinks he doth protest too much. If it walks like a duck and quacks like a duck, well you get the picture.

-- posted by mdorsey

http://cbs.marketwatch.com/news/story.as...

Top 83. Jul 24, 2001 1:22 PM

» Rande - Vanguard says nay to market timing way:

Vanguard says nay to market timing way:

Vanguard targets market timers

VALLEY FORGE, Pa. (CBS.MW) - Vanguard is taking steps to prevent market timers from shuffling money in and out of its rapidly growing Selected Value Fund.

The company raised the fund's (VASVX: news, chart, profile) minimum initial investment amount from $3,000 to $25,000 for both taxable accounts and IRAs, effective Tuesday.

In addition, shares bought after Aug. 6 will be subject to a redemption fee of 1 percent if sold within five years of purchase. The fee will be paid directly to the fund to compensate shareholders.

"The board was worried about investors chasing performance," spokesman John Demming said.

The Selected Value fund has returned 32 percent over the past 12 months. Meanwhile, assets in the fund have grown form $196 million at the start of the year to $791 million through the end of June.

Short-term investors can harm a fund's performance by generating added transaction costs and forcing managers to sell stocks they would rather hold.

Vanguard recently instituted redemption fees and raised minimums for its $17 billion Health Care fund (VGHCX: news, chart, profile) and the $21 billion Primecap fund (VPMCX: news, chart, profile) as well.

The company leads the fund industry in net cash flows this year, with $15.6 billion through May, according to Financial Research Corporation.

Admiral Shares

Vanguard also has filed with the SEC to expand its low-cost Admiral Shares program to six additional funds, the company said Tuesday.

Admiral Shares offer lowered expense ratios to shareholders with large and long-tenured accounts. Required minimums range from $250,000 for new accounts to $50,000 for accounts opened at least 10 years ago.

-- posted by Rande

Top 84. Jul 25, 2001 6:27 AM

» Rande - Re: Vanguard says nay to market timing way:

In response to message posted by Rande:

One interesting observation/question about the anti-market timing campaign at Vanguard:

Why do you suppose they would think that raising the minimum from $3,000 to $25,000 would discourage market timers? Perhaps it's because they understand that those with more to lose are less likely to act irrationally, are more likely to be better-educated in the ways of prudent portfolio management. Maybe they figure that it's the ever-contrarian "little guy" who is most likely to jump in and out on every emotional whim of the moment. Makes sense.

-- posted by Rande

Top 85. Jul 25, 2001 7:18 AM

» R_Lewis - Re: Re: Vanguard says nay to market timing way:

In response to message posted by Rande:
Those with more to lose could lose more if they don't time at timely time. It depends on how much time you have. My time is getting shorter and shorter.

Richard Lewis

-- posted by R_Lewis

Top 86. Jul 25, 2001 7:22 AM

» Rande - Re: Re: Re: Vanguard says nay to market timing way:

In response to message posted by rich8rd:

Oh, there's no disputing that anyone would be better off timing "at a timely time." Too bad the process of predicting the future is so, well, unpredictable. Those with more to lose tend to understand that timing is just not worth the costs of being wrong. So, they generally opt for the more prudent approach of a long-term asset allocation which is designed to meet their goals by allowing them the luxury of not freaking out as those without a plan in place are apt to do when the going gets tough.

-- posted by Rande

Top 87. Jul 25, 2001 7:26 AM

» KLR - Profiting From the Blahs

Here's a lengthy article regarding a technique called "systematic writing"[of options], as one way to make money in trendless times. I like the part about no upfront investment and limited downside...

Tradecraft
Profiting From the Blahs

By Jonathan Hoenig
July 19, 2001
IN APRIL of 1999, The Matrix was in theaters, Columbine was in the headlines and the Dow Jones Industrial Average traded near 10500. Now fast forward to present day, where the movies and news have all changed, but the Dow is still hovering near 10500. Of course, there's been plenty of movement this way and that in the meantime, but if you've been a long-term investor in the Dow stocks, your money has been dead for over three years. Sometimes stocks go up, sometimes they go down. But often they go nowhere at all.

A technique called "systematic writing" is one way to make money in trendless times. It's a neutral to bullish strategy that requires no upfront investment, has limited downside and can be highly profitable in times when there's no clear direction to the market. It's also a great way to dip your toe into options trading and begin integrating income-oriented strategies into your tool kit of technique.

First, a quick review of some basic options terminology: A stock option is the right to either buy or sell 100 shares of a stock at a predetermined price (the "strike price") within a specific period of time in the future, any time before what's known as the "expiration date." A "call" option represents the right to buy, while a "put" represents the right to sell. Buying an "XYZ Sept. 50 call" gives you the right to buy 100 shares of XYZ at a price of $50 a share anytime before the end of the third Friday in September. Buying the put would allow you to sell 100 shares of XYZ at $50 a share anytime before that date.

Many sophisticated stock jocks are familiar with buying both puts and calls. Systematic writing, however, doesn't involve buying options, but selling them. In the options world, "writing" means "selling" — and it all starts with a put.

A put, you'll remember, represents the right to sell. It's a form of insurance policy: Traders buy puts when they think the market is going to drop. Systematic options writing starts with the sale of a put. Instead of buying insurance — you are selling it. And as Warren Buffett explained in his 1997 shareholder letter, the insurance industry has a pretty nifty business model.

Know Your Options
Buying a call gives you the right to buy
Buying a put gives you the right to sell
Writing a call gives you the obligation to sell
Writing a put gives you the obligating to buy

When you sell short a put (sell a put you don't own), you are obligating yourself to buy 100 shares of XYZ stock at the strike price, any time before the expiration date. In exchange for making that promise, you receive the option's premium, or the price at which it's currently being traded.

For example, let's say that with XYZ at $50, the January 2002 XZY 45 put is trading at $2, or $200 per 100 shares of stock. Sell short the put, and you will receive the $200 upfront. The only catch is that you've obligated yourself to buy 100 shares of XYZ at $45 (the strike price) anytime before trading ends on the third Friday in January. Depending on your broker, you have to have anywhere between 20% and 100% of the equity needed to actually buy the stock sitting in your account — in this case, $4,500. Because the cash is simply collateral and not actually invested, you'll continue to earn interest, making this strategy another great way to give your cash some flash.

After you sell the put, one of three possible scenarios will occur. The stock will move higher, lower or, like the Dow over the past three years, remain basically unchanged. Systematic writing gets its name because there's a specific, almost automated follow-up trading maneuver, no matter which possibility unfolds.

Let's say that when expiration day rolls around, XYZ has moved higher or at least stayed above $45 a share. The put option you sold for $2 ($200) will be worthless — after all, why would someone want to exercise the right to sell you XYZ at $45 when it's trading for more on the open market? As long as XYZ is above the strike price at expiration, you'll pocket the entire premium. This is the preferred scenario. At that point, you start the process over again and write another put.

On the other hand, let's assume that XYZ drops from $50 to $43 by expiration. The bad news is that you'll be "put" the stock — forced to buy XYZ at $45 a share — even though it's trading on the open market for only $43. The good news is that again, you'll keep the $2-a-share premium you initially received for selling the option. So although you'll be assigned 100 XYZ at $45, you're essentially buying the stock for $43. ($45 - $2).

Now you own 100 shares of XYZ at $43. Your maximum risk is $4,300, because the lowest the stock can go is to zero. But it's not the goal of the systematic writer to bet on the market's direction, but to profit regardless of its direction. It's a way to get paid without having to be terribly opinioned on the market's next move.

So as a follow-up to being put the stock, the systematic writer will then sell a straddle, or both a call and a put. Let's see how that will affect the position's risk-reward profile moving forward.

We last discussed selling covered calls within the context of hedging. A call, as you remember, is the right to buy. Selling short a call, therefore, is an obligation to sell. So the systematic writer, now long 100 shares of XYZ at $43, would sell a $43 call, obligating himself to sell 100 shares of XYZ at $43 anytime before the expiration date. He would also sell another put option, with a $43 strike price, obligating himself to purchase yet another 100 shares of XYZ at $43.

Source: "Options: Essential Concepts and Trading Strategies"

Let's get specific. With XYZ at $43, the June 43 call might have a premium of $3 ($300). The XYZ June 43 put, which obligates you to buy another 100 shares of XYZ at 43 anytime before trading stops on the third Friday in June, might have a premium of $2. So in exchange for selling both options, the systematic writer would receive a total of $5 ($500) in option premiums. Once again, only three possible scenarios can unfold. XYZ can rise, fall or stay exactly the same.

Now expiration rolls around once again. On the off chance that XYZ ends up at exactly $43 a share, both the put and call options you wrote will expire worthless and you'll keep the $500 in premium. You are still long 100 shares of XYZ at $43, but because of the premium received, you've lowered your cost basis to $38 a share. The stock hasn't moved, but you've still made money. At this point, you could sell the stock, or even better, write another straddle and collect another round of premium.

Let's assume that, at expiration, XYZ has rebounded back to $45 a share. The put option will expire worthless, as XYZ is trading above the $43 strike price. You'll keep the entire $2 premium. The call option, however, will be assigned, because the stock is trading above the call's strike price. You'll be forced to sell your XYZ at $43. Again, you'll keep the $3 premium, netting you a total of $500 and leaving you "flat." Now it's back to the beginning — time to write a brand new put.

Worst-case scenario? Let's say XYZ falls again, this time to $38. The call will expire worthless and the put will be assigned, forcing you to buy another 100 shares of XYZ, this time at $43. But because you've collected $500 in premium, you've again lowered your cost basis, this time down to $38 a share. You've been put 100 XYZ at $45 and 100 more at $43, and with the stock now at $38, you're down some money. After all, you've been wrong twice in a row and seen XYZ drop from $50 to $37, or almost 24%. But because of all the premium received, you're down only $500 on the entire position. Now your maximum risk is limited to $7,600 (200 shares of XYZ at $38 a share).

Now you're long 200 shares of XYZ with a cost basis of $40.50 With the stock at $38, the December $38 calls might be selling for $3 or $300. By selling two calls, you're obligating yourself to sell all 200 shares of your XYZ at $38 a share, anytime before the expiration date. Once again, you'll receive a premium in exchange for selling the calls — this time, $600 (two calls x $3 ($300)). This now lowers your cost basis to $34.50.

If the stock is above the strike price before expiration, your calls will be exercised and you'll be forced to sell your XYZ at $38, leaving you a $100 profit on the entire trade. If the stock drops to $34, you're down only $50 on the trade, even after having been wrong three times in a row. XYZ has dropped 28% since you first began writing puts, and you're only fractionally in the red.

A major factor in determining your success with systematic writing is commissions. Unfortunately, the cost of trading options hasn't yet dropped the way the cost of trading stocks has. Expect to pay at least $15 a trade, which makes it advantageous to deal in slightly larger lots positions if possible. If your account size allows it, try doubling up. Instead of selling one put off the bat, sell two. Choose a position size that's appropriate for your account.

The standard disclaimers: Selling options, even when there's limited risk as in systematic writing, is most appropriate for sophisticated investors or bored stock traders looking to up their game. And because this should be considered only an elementary introduction to such tactics, the first order you place shouldn't be for a option, but for a book. One of my favorites is "Options: Essential Concepts and Trading Strategies," published by the educational division of the Chicago Board Options Exchange. For the absolute beginner, "How I Trade Options" by John Najarian is an ideal introduction. More savvy stock pros will appreciate Larry McMillan's beefy "Options as a Strategic Investment." No matter what your level of expertise, reading the CBOE's boilerplate risk disclosure document is a must.

It's a tough world out there, and nobody knows the future. But when used appropriately as part of a diversified investment program, systematic writing is an efficient and low-risk way of getting the market to pay you not to have an opinion, rather than ponying up to the greedy SOB for the privilege of having 'em in the first place.

Jonathan Hoenig is portfolio manager at Capitalistpig Asset Management, a Chicago-based hedge fund

-- posted by KLR

Top 88. Jul 25, 2001 12:47 PM

» SteveT - Re: Re: Re: Re: Vanguard says nay to market timing way:

In response to message posted by Rande:

I am not saying it is impossible to correctly "time the market" I am just saying the odds are against it.

If you will draw a small square box with four smaller equal sized squares in the Bigger box. Outside the big box label the X axis "action" and the Y axis time. Under the action axis you can either take the right action or wrong action. Under the Y axis, time you can either take action at the "right time" or "wrong time."

Fill in the blanks so to speak. You have 4 outcomes. 1. Right action at the right time. 2. Wrong action at the right time. 3. Right action at the wrong time. 4. Wrong action at the wrong time.

So you see, the odds of getting it right on both are one in four. Three out of four times you will make a choice that has the word wrong in it. If you are lucky two of them will not devastate you. But, that wrong action at the wrong time just could.

Throw in the added transaction costs, paying taxes earlier than you have to, and emotional strain. Is it worth it? To me the chances of taking the wrong action at the wrong time is far more risky than a proper allocation buy and hold style. But hey, that's me.

-- posted by SteveT