Few financial endeavours
have occupied the time of more men over more years with less success than
attempting to "beat the market". So many have tried and failed that it has
become popular to believe that no one can consistently outperform the averages.
"Nothing could be further
from the truth! Some (equity) investors, utilizing more sophisticated
approaches than the public at large, can earn much higher returns, year in and
year out," says the author of this article. And such higher returns from stocks
can lead to "riches beyond the dreams of avarice". Read on to find out how"
quest by fundamentalists and technicians alike to discover the secret of
calling market turns is driven by a knowledge of the incredible returns a
completely successful timing strategy would yield.
example, that from early 1964 through the end of 1984, the average New York
Stock Exchange common stock provided its holders with a total return from
dividends and capital appreciation of 11% per annum compounded. By comparison,
an investor with the intelligence and foresight to step out of stocks and hold
cash during the three bear markets of the period could have earned nearly twice
that return — 21% per annum compounded. He could have achieved such a
performance without ever picking a single stock or speculating on margin; by
merely buying and selling "the market" (which is easier than you might think).
illustration a step further, an investor who actually sold the market short
during the three bear moves (instead of just holding cash) would have reaped an
additional profit sufficient to increase the compounded return to 27% per
annum, a stunning cumulative return of 13,812% (see Table 1).
But let us
take our illustration yet a further step. An investor who perfectly forecast
every up and down market swing of at least 5% during those years, buying just
before each up move and selling short just before the market was about to drop
5% or more, would have garnered a return approaching an astounding 52.4
million percent, equivalent to nearly doubling his money every year!
forecasting even small price swings would naturally lead to even larger
profits, although ultimately (broker) commission costs would equal the size of
the swing itself and eat up all gains.
So the next
time you hear someone say that all you need to do is buy good stocks and hold
them, think of these comparisons of "buy and hold" with various
market timing strategies.
few investors ever time a single market cycle to perfection, much less repeat
the feat year in and year out.� And
accurately timing all market moves as small as 5% is simply impossible. Indeed,
the incredible returns of the short term trading strategies shown in Table 2
demonstrate how improbable such perfect timing is. Thus, the endless quest for
new market timing techniques is based less on a belief that perfection is
achievable than on an understanding of how profitable even the slightest
success in market timing can be.
attainable levels of market timing success can have a dramatic impact on
overall returns. For example, an investor who was short for only one-quarter of
each of those three bear markets in the past twenty years would have spared
himself half the losses incurred by his fully invested counterparts, and his $
10,000 would have grown to $237,790 � tripling the profits of buy and hold.
magnitude of returns constitutes a realistic expectation is a function of the
degree of forecasting accuracy that can, in practice, be achieved.� It might seem likely that accurate market
forecasts for the next few days would be relatively easy to achieve, and that
any prediction of prices six months or a year in the future would be highly
conjectural. Interestingly enough, exactly the opposite is true; long-term
market cycles are much easier to anticipate than day-to-day wiggles in the averages.
Furthermore, besides being exceedingly difficult to predict, small, brief price
movements are rendered even less profitable by the burden of repeated
Be it from
impatience or curiosity, most investors are unduly concerned about what the
market will do in the next few days when their attention would far better be
focused on where the market will be in three, six, or twelve months. The
answers to questions about tomorrow's ripple may be more interesting, but
answers to questions about the major trend are ultimately far more profitable.
surprisingly, many of the academic studies that have concluded that successive
stock price changes are random (unrelated to one another), have analyzed only
very short term market movements, which do exhibit a large random
component.� However, when the longer
term, which has been all but ignored by random walk theorists, is viewed in the
light of market forecasting indicators, it becomes clear that the market does
not follow a random pattern, and that superior profits await equity investors
willing to follow the guidance of those indicators.