Saturday, 4 August 2018

You Could be Unknowingly Timing The Market with These Actions

Most, if not all, of the investors I encountered agree that it is extremely difficult to time the market successfully, meaning trying to buy at absolute bottom and sell at absolute high to earn maximum profits.

But I see many investors deciding their buying and selling that are supposedly based on sound rules and experience, but are actually timing the market unknowingly.



I believe the underlying reason for such behaviour is due to emotional biases in investing. One is the anchoring bias, and the other is the tendency to project future price movement based on recent patterns. For the latter I can't find an official name for it. I suspect it could be Status Quo bias.

Anchoring and 'Status Quo' Bias
Investopedia define Anchoring Bias as 'the use of irrelevant information, such as the purchase price of a security, as a reference for evaluating or estimating an unknown value of a financial instrument.'

'Status Quo' bias, applied to investing, should be the action expecting a share price to further move along the same trajectory in the period right before the mental decision is set.

How do they play out in real life?
Let's take Singapore's arguably favourite share - DBS as an example.

In the case of anchoring bias, an investor could have bought DBS at below $20 early 2017, held  and sold it at $25 early 2018. In his mind $25 is the anchor price above which he would never consider to buy at all. In his mind he is probably thinking that i sold it at $25, it would be foolish to buy now at $27 as it is so much more expensive now. This decision to withhold from buying is purely derived from mentally dropping a pin at $25 price, regardless of improvement in DBS business fundamentals and increased earnings.

For 'Status Quo' bias, let's use another Sg favourite share - Singtel. Its share price has been dropping from around $3.80 to low $3. It recently found a low at $3 and rebounded a little. An investor who had long been attracted by the stability of this company and its enticing yield of > 5% wanted to buy. But he mentally projected that Singtel would continue falling to sub $3 soon simply based on the relentless fall in share price past 9 months.

Both cases illustrate the way our cognitive brain functions. Given human DNA to look for pattern and reasons in short term share price movement that can be random, these investors base their investment decisions upon mental shortcuts played up by the brain that are often fickle. Just where/how do people conjure up reasons to substantiate above actions are intriguing, but they without fail still legitimise these buying behaviours.

Sounds familiar? These may be some subconscious market timing that many many investors engage it unknowingly.

These Are Not Market Timing
If one buy/sell using Technical Analysis, premised upon a set of well-defined rules developed from deep understanding of technical indicators and own market experience, and these rules don't change on the whims, he is not market timing.

If one buy/sell based on careful considerations of company's past results, qualitative factors such as its competitive edge over competitors, and in turn forming an opinion about its prospect and an expected pricing outcome in a rough timeline, he is not market timing.

If one aims to profit from trend reversal and set up his trade plans based on thorough study of volume, price charts, coupled with independent opinions on funds flow and corporate actions, with corresponding loss-mitigating trade actions in case his opinions are wrong, he is not market timing.

But if he/she is buying/selling based on gut feel and quick 5 seconds glance at price chart, motivated by the underlying desire to buy at lowest sell at highest, he/she is market timing, no matter how 'legitimate' his reasons are.

When such actions are undertaken regularly on a long term basis, his/her investment actions plans are not based on rules, system and logic, but rather, hunch and luck. Chances are long term returns would not be satisfactory.

So do spend some time to think about if you are actually investing or timing the market.

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3 comments:

  1. Recency bias.

    Actually all you've described IS market timing. Warren Buffett is an infamous market timer. So are all those famous billionaire hedge fund managers.

    Market timing is not wrong ... what's important is how it's being done. Like you say ... gut feel & emotional ... Or well thought out tried and tested process?

    The opposite of market timing is simply to keep buying the entire market ... all the stocks ... and keep buying for 40-50 years until retirement & beyond. This is the approach preached by Jack Bogle, and also Buffett for retail investors.

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