investing

How To Time The Market

August 8th, 2013

Stay up to date

This blog post was originally published on the MoneyGeek.ca blog by Jin Choi. The website no longer exists, but Jin has graciously allowed us to re-publish his research for the benefit of future investors forever.

They say that it's impossible to time the market. In other words, it's impossible to know when it's the best time to invest in financial assets.

I submit to you that while it's very difficult, but not impossible to time the market. In this post, I'll tell you the methods that have worked for me.

Note these methods have helped me time the markets within months, not days or hours. In other words, I've had to endure up to a few months of losses, before it became apparent that I've timed my purchases correctly.

The art of timing the market within days, hours and minutes is called 'Technical Analysis'. I don't use technical analysis, and I don't generally recommend other people to use it either.

Anyways, let's talk about how to time the market

Listen To Your Emotions, And Do The Opposite

Every now and then, there's a stock or some other asset that keeps going up, or keeps going down. Keep a close eye on the price changes every day, and listen closely to your own emotions. Feel it. Let it communicate to you.

After a while, if the asset's price has been going up, you will feel this supreme confidence that the asset will go up tomorrow. You will feel as if it's a sure bet.

This is the right time to sell the asset.

Understand that this is hard. Your emotions will object. It'll say, "What are you doing, throwing money away?". It takes guts to ignore your own emotions.

But this is exactly what millions of other people are feeling right this moment, as they pile into the popular asset. When the last of such emotional investors have piled in, no one else will want to buy the asset, so its price won't go up.

When those feelings of confidence subside (and they will), those same people will sell their assets. This often leads to a crash.

Make Sure You Know Its Objective Value

Conversely, if an asset's price continues to dive, and your emotions tell you that you're foolish to buy it, that's the right time to buy.

However, there's a caveat - the value must be on your side.

For example, if a company turns out to be a fraud, many people will dump its stock. The stock's price will decline almost every day.

If you have good reason to believe that the company's not actually a fraud, sure, this is a good time to buy. But if it IS a fraud, the stock is going to 0. Don't buy the stock, hoping for a bounce.

Figuring out the objective value of an asset is hard. If you want to learn how to do it, stick around our blog. We'll explore that topic from time to time.

Watch For Correlation

Correlation is term that describes how assets behave in relation to each other.

For example, let's say that when stock XYZ goes up, stock ABC goes up too, and vice versa. If that happens, we say that the stocks are correlated. If stock XYZ goes up when stock ABC goes down, we say that the stocks are anti-correlated. If the stocks have no effect on each other, we say that the stocks are uncorrelated.

If an asset becomes very popular, investors sell other assets to invest in that popular asset. If an asset becomes unpopular, investors sell that asset and buys other assets. When either of these happen, the asset in question becomes uncorrelated, or even a little anti-correlated to the market.

However, when investors have completely piled into the market, the asset no longer becomes uncorrelated. Investors no longer sell the asset to buy other assets, and vice versa. Instead, as investors obtain more cash, they buy a bit of every asset, or as they lose cash, they sell a bit of every asset. As a result, the assets become correlated.

In other words, if assets become correlated, it means that everyone who bought the hype, has already acted on the hype. This is the optimal time to act against the crowd - whether through buying or selling.

Case Study: Shorting Gold

I shorted (bet against) gold in August 2011, when it was trading above $1,800 an ounce.

Until that time, gold was having an incredible run. It had been going up every single year for a decade. But during the months leading up until August 2011 especially, the chorus of gold bugs became louder and louder.

Everywhere I turned, someone was recommending gold as an investment. I knew friends who invested in gold. I couldn't read newspapers or investing blogs without reading someone commenting on gold.

As a result, gold had an especially spectacular run-up from June 2011 to Aug 2011.

I listened closely to my emotion. I felt the familiar confidence that it will go up again the next day.

At the same time, I knew that I disagreed with the gold bugs. I understood the samed old rehashed arguments they made - that the Federal Reserve was printing a lot of money, and that that will lead to high inflation. I've also always held a dim view of gold as an investment.

I watched the price movements of gold very closely. In August 2011, I began to observe that gold went up when stocks went up, and vice versa (i.e. correlated). This was different from the usual behaviour of gold, which went up when stocks went down, and vice versa (i.e. anti-correlated).

That's why in August 2011, I decided to bet against gold. Luckily for me, it's turned out well.

Conclusions

I'm not going to guarantee that this works a 100% of the time. I can only say that it served me well in the past.

Following this method is hard for the average person for 2 reasons. It's difficult to act against your own emotions, but more importantly, it's difficult to know whether you've correctly assessed the value of a financial asset.

For these two reasons, I generally don't recommend people to time the market. However, if you're especially curious or ambitious, I invite you to try to time the market with small sums - if for nothing more than your amusement.

On the other hand, if don't want to mess around with timing the market and such, I invite you to sign up for your newsletter below. I'll talk about the different trends we see in the financial markets, and keep you grounded in sound investment principles.

This blog post was originally published on the MoneyGeek.ca blog by Jin Choi. The website no longer exists, but Jin has graciously allowed us to re-publish his research for the benefit of future investors forever.