Timing and Risk in Trading

A great excerpt from Tom Basso, taken out of Financial Planning Magazine:

Why then would we want to time the market, if all the studies have shown that actual client timing is so poor? The answer is that actual client timing has been driven more by investor psychology than logic. Our simple timing strategy (or more sophisticated ones used by many investment managers) forces the investor to buy when the market is moving up, not question the direction or how long the move will last. It forces the investor to sell out of the market after he’s made large profits, is euphoric with the market, but the market starts to move lower. It helps to provide the discipline that the typical investor lacks. Another psychological aspect that drives me to use timing techniques on my portfolio is understanding myself well enough to know that I could never sit in a buy and hold strategy for two years during 1973 and 1974, watch my portfolio go down 48% and do nothing, hoping it would come back someday. Timing strategies give me the psychological lift that allows me to react to market risks and modify my exposure to those risks over time. It’s empowering to be able to know that I can cut losses short and let gains run. It keeps my investing mind concentrated on doing the right thing each day, rather than succumbing to all emotional swings that most investors go through in up and down markets. If an investor’s mental process is not sharp and disciplined, the market has ways of teaching that investor what risk really is.

Another Thought from Tom Basso:

Investors who time the stock market are constantly faced with the prospect of becoming impatient when, over a shorter time frame, there doesn’t seem to be value added by a timing strategy. Frequently, their excuse for abandoning a timing strategy is it doesn’t work anymore or I could have made more money with a buy and hold strategy. Investor psychology is heavily at work here. The investor, at that point, does not remember why they developed or started using their timing strategy in the first place. Many times I have seen investors forget what to expect in the best case, worst case, and expected case scenarios. I maintain that if the investor can understand exactly what to expect from a strategy, they will be less surprised when the timing strategy does exactly as expected. I constructed this study to help investors learn more about the action of the stock market and what timing programs generally should provide the investor.

More thoughts from an excerpt of, A Perspective on Risk by Jim Little, and Sol Waksman:

Sound investment policy is really about intelligent risk management. There is no such thing as a risk free investment. Even an investment in cash exposes the investor to the risk that his buying power will erode through inflation. The real issue is not whether you want to take risk, but which risks and how many of them you are willing to accept. To make intelligent decisions as to how much of a particular risk is right for you, and how to blend risks properly to lower overall portfolio risk, you must have accurate measurements about how much risk each sector of your portfolio is exposing you to. Some investors rely on conventional wisdom (or lack thereof) to dictate their asset allocation. Others rely upon outdated statistics. The wise investor continues to study the facts.

And another excerpt from, We Have Met the Enemy by Jack D. Schwager:

We have met the enemy, and it is us. This famous quote from Walt Kelly’s cartoon strip Pogo would serve as a fitting universal motto for investors. In my experience, investors are truly their own worst enemies. The natural instincts of most investors lead them to do exactly the wrong thing with uncanny persistence. In a nutshell, the heart of the investor blunder is the tendency to commit to an investment right after it has done very well and to liquidate an investment right after it has done poorly. Although these types of investment decisions may sound perfectly natural, even instinctive, they are also generally wrong…I would like to relate two personal experiences that made me appreciate this general principle in very real terms. The first occurred about a decade ago, when I worked for a firm where part of my job responsibilities included evaluating commodity trading advisors (CTAs). I made the striking discovery that the majority of closed accounts showed a net loss for virtually all the CTAs I reviewed–even those which had no losing years! The obvious implication was that investors were so bad in timing their investment entries and exits that most of them lost money even when they chose consistently winning CTAs. It goes against human nature to invest in what has been going down instead of what has been going up.

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