Managing an investment portfolio is not an easy task. Recently we wrote about the importance of risk diversification and rebalancing the investment portfolio. There is another point that also needs to be respected – market timing. What is this? We will report in a step-by-step manner in this article.
Definition
Market timing is a strategy for choosing the right and successful time to buy an asset. Let’s look at an example.
A novice investor wanted to find a company from which it is possible to buy shares profitably. After the market has been thoroughly studied, he understands that it is possible to purchase shares of one company in the field of IT technologies. The investor begins to learn the details of the company’s life. On the Internet, he reads the news that a complete change of the management team is planned in a month. However, the news was found on one of the many different online media outlets where fake news is rarely published. Let’s analyze how events can develop further:
- The news was unreliable. There have been no internal or external changes within the management of the company, so the investor purchases the shares of the company at approximately the same value at which they were sold.
- The news turned out to be true. At the end of the stated month, the entire internal management changes and new managers come in. Why did this happen? Most likely, the board was not satisfied with the state of affairs of the company, which is why this decision was made. According to the board, the new managers are able to change the company’s performance and this will affect the growth of profits. At the same time, there is a nuance: almost always, when the management changes in organizations, the share price of this company falls. It turns out that regardless of the professionalism of the new management, it is still too early to talk about the successful development of the company. This outcome is interesting because it has two options for the further development of events.
- The management has changed, the share price is falling. After the end of the new quarter, the company’s profit increased by 30%, after the publication of reports, the share price increased.
- The management has changed, the share price is falling. However, it turned out that the new managers did not meet expectations and the company’s profit decreased by 15%. After the publication of quarterly reports, the share price sags even more.
From this example, we conclude that if an investor bought shares of a company when they were falling, two outcomes can be expected: he will earn if the company’s quarterly profit increases, or he will suffer losses if it decreases. It is believed that after a long downtrend of the asset, growth should go. However, no one is immune from any political events or global financial crises. And it will be good if the investor has extra money to wait out the drawdown of assets, it is much worse for those who start selling them in order to somehow stay afloat.
Entry and exit points
There is one important rule when buying any asset that should not be forgotten: when looking for a favorable moment, someone else wants to make a profit from your invested funds. When there is strong volatility in the market, it is quite problematic to wait for a good moment, because profitable and unprofitable days follow each other. This means that while one investor makes a profit from his assets, the second one loses it. This is the market process. Therefore, you need to try to find a favorable moment for entering and exiting the transaction, so that the profit is more noticeable, and the losses are not so strongly felt.
Often, investors use technical analysis tools to find the right entry to a deal, namely:
- The level of support. This is the price level that is below the current price. It is called the support level because the price has already tried to break below, but it often turned around at this level.
- The resistance level. This is the price level that is higher than the current price. It is called the resistance level because the price tried to rise higher, but also, reaching this level, it turned around.
More favorable moments are found with the help of support and resistance lines. They can be seen on the chart as horizontal lines with a slight slope. Those people who know what such lines and levels are, understand that their breakdown is a favorable moment for opening or closing a deal. However, you also need to be careful here, since this breakdown may turn out to be false, and the price will turn in the opposite direction. You can avoid such an outcome by tracking the price for several days. If the chart clearly shows that the asset price has tested this level several times, but could not go further, and now there has been a breakdown, then this means a favorable moment. For more confidence in buying or selling, you can follow the schedule for a few more days.
In addition to technical analysis, you also need to use fundamental analysis. It will also help to detect a favorable moment for the transaction. An example of fundamental analysis was described above. It is necessary to observe the company’s activities well: follow the news, get acquainted with the latest reports, compare the asset price with the company’s net profit.
How to correctly determine the right moment?
There are several points with which you can understand the propensity of the moment.
- The first thing to do before determining a favorable moment is to draw up a clear action plan and trading strategy. If there are these two components, it will be much easier to determine the right moment for investment. In addition, the investment portfolio must be balanced so as not to incur losses.
- Monitor the support and resistance levels, breakouts of these lines.
- During strong volatility in the market, it is worth refraining from opening deals. At such moments, you can find a lot of false breakouts on the chart. Therefore, there is a risk of opening a transaction either at an inflated asset price, or incur losses.
- As mentioned above, technical and fundamental analyses can help to determine the right entry point. Also, up-to-date tracking of news about the assets of the selected company.
- Stress tolerance. The ability to control yourself and to remain calm in a time of market instability is an important factor.
- And of course, experience will be a good assistant in determining favorable moments. At first, you can simply follow the graphs of the asset you are interested in, without investing. To draw some conclusions for yourself. After a while, I started trying out as an investor.
Pros and cons
The main advantages of market timing include two factors:
- In the case when the investor has learned to identify favorable entry points, any available funds can be invested with further profit.
- Tracking the right moments with the help of support and resistance levels will give an understanding of the trading world as a whole.
The disadvantages include a high risk, which is accompanied by two factors:
- The global economy is not immune from unexpected shocks. For example, you can take the current pandemic or the financial crisis. Such moments can affect the financial markets as a whole.
- No matter how experienced an investor is, he is not able to predict 100% correctly the moments with favorable entry points. It is impossible to be completely sure of their onset, for one simple reason-this is the market. There will always be doubts in any forecast.
Conclusion
Market timing can help you choose the right moment to make a profit from the entire operation. Basically, this theory is used to enter the market, to exit, it is not quite suitable. If the price of an asset falls, there may be two reasons: investors have lost interest in the asset or its holders are selling off in a panic. In the first option, it all depends on patience. After all, sooner or later, investors ‘ interest in the asset will return. In the second option, after a panic sale, you need to wait for the situation to calm down. After that, the asset will start to pay off and return to its previous positions.