Thursday, June 28, 2007

Should You Try to Time the Market?

I recently found this post arguing against the Buffett style "buy and hold" investor. Citing to a book by Ben Stein, the post argues that the whole "no one can time the market" advice is an oversimplification, and that by working the numbers you can avoid predictable decreases and cash in on predictable upswings.

Specifically, buy whenever the following valuation ratios fall below their 15-year moving averages: price-earnings, dividend-yield, price-book, price-cash flow, and price-sales.

It strikes me that the two are not mutually exclusive. A value investor like Buffett takes the value of the stock at the time of purchase into account when he buys it, thus in a way he is timing the market.

When to Sell

The difference comes down to whether to sell or not when the stock becomes overvalued. Buffett's advice is usually reported as "sell rarely, if ever," but this does not seem like a prudent course for the ordinary investor.

Unlike Buffett, I can't run the companies I am buying into so as to ensure high returns on my investment. If my stocks become overvalued there is little I can do to maximize my return except sell and invest elsewhere. Of course, I might miss out if the company's long run growth remains stellar, but there is nothing preventing me from buying back into the company once it becomes less overvalued.

The buy and holders have a legitimate point, however, when they emphasize not overreacting to short term swings in the stock price and selling like a panicked feline. I am going to try not to panic at the first downswing.


Anonymous said...

my question would be, as a very first time stock purchaser, is there a general "rule-of-thumb" about how much money one should invest in their first stock?

Alex said...

The answer seems to depend on how risky the stock is, but the general rule I have heard is to have no more than 5% of your investments in any one stock.


Timing the market is something thats misunderstood. If Timing means picking the high on the dow jones industrials than I would say thats silly but if timing in the sense of tryimg to buy an index fund when its down from its high of five or six years ago today like the Home building index. Ishares has an exchange traded fund thats narrowly focused on home building stocks which are down by something like 75% from their highs than I would say timing is a great idea.