Mousetrap 3/24/2012 -- why market timing doesn't work

Condition Bear Market Rally
S&P Target 1020
Small Portfolio IAU & XLF 15.61%
Hedge XLU -1.21%

Position Date Return Days Call
GCI 7/14/2011 17.66% 254 Hold
CSGS 10/3/2011 23.42% 173 Hold
NLY 10/25/2011 2.78% 151 Hold
DD 10/27/2011 16.09% 149 Hold
KBR 10/27/2011 26.01% 149 Hold
VG 10/27/2011 -32.52% 149 Buy
TTM 11/30/2011 59.23% 115 Hold
BT 1/4/2012 18.28% 80 Hold
PDLI 3/7/2012 4.11% 17 Hold
CLF 3/19/2012 -1.74% 5 Hold

S&P Annualized 4.73%
Small Portfolio Annualized 19.13%
Mousetrap Annualized 23.39%
Hedged Annualized 21.91%

Market timing is the holy grail of investing. If you can be long SPY when it’s going up and short SPY when it’s going down, you can make a mint.

There are a few – very few – who can do it. My friend Len can do it. EffectiveVolume.com can do it.

A lot of other folks WOULD be able to do it too, except for one problem: timing the market means that your trading costs accelerate. If you trade just under once a year, you might have trading costs of 1% or less, and 30% capital gains taxes.

At just longer than once a year the capital gains are cut to 15%.

But market timers generally trade every few weeks, with stop losses in place. Day traders are even worse. A day trader with just one trade a day and a nest egg of 2000 dollars would lose at an annualized rate of 365% a year. At 20,000 dollars that’s 36.5% a year losses on trading costs – BEFORE you even consider the wins. I mentioned last week that a person using something like my Mousetrap model with 20,000 dollars would have to hold over two months just to break even – BEFORE you even consider the wins.

And that’s why market timing doesn’t work: trading costs and taxes eat you alive, UNLESS you are that extremely rare person like Len or the folks at EffectiveVolume.

So how long should a person hold? Ideally, more than a year.

You’ll note that I haven’t been doing that, and that’s why my performance has been so bad. Yes, a 23.39% annualized rate is rather attractive. But if I had not sold any of my stocks my annualized gains would be at a 43.13% rate.

That’s a 20% performance hit because I was trying too hard.

The good news is that I’ve paid attention to the bad news, and I’m now mining data to find the ideal holding period. So far it appears to be around 558 days per trade. That will fine tune as time goes on. But it gives me the happy circumstance of making a trade every two months or so as I rotate between ten stocks – and the next trade doesn’t have to be for a long while. Granted, if there’s a drastic money flow change like there was with GTAT last year, I would make that trade. But I believe GTAT was the only stock of the first ten I should have traded by now.

This model is about to get REAL boring, then, with very few changes.

My realized return goal is 30% a year – on average. I think, by slowing down… slowing WAY down… that’s a reachable goal. Others may be able to do better, but 30% after trading costs and taxes would meet most folks needs… certainly my own.

We’ll see.

But with only a trade every two months or so, I might be able to take a vacation AND sleep at night too :-).

Tim

[QUOTE=Timothy Clontz;21480] ... I’m now mining data to find the ideal holding period. So far it appears to be around 558 days per trade ...[/QUOTE]


Tim,

Is that 558 calendar days or 558 trading days?

Neil

Calendar days.

What about frequent trading within a Roth? As I understand, as long as you don't trade the same equities with other accounts (avoid wash sales) you can trade as frequent as you want without tax implications.

Yes, an IRA account avoids the tax burden, but not the frequent trading costs. It's those little 9 dollar transaction costs that kill you.

A system has to beat the market AND taxes AND transaction costs AND inflation to truly "beat the market". I think Billy and Pascal can do that, but most people can't do it on their own unless they use a fundamental approach, instead of a technical one.

[QUOTE=Timothy Clontz;21506]Yes, an IRA account avoids the tax burden, but not the frequent trading costs. It's those little 9 dollar transaction costs that kill you.

A system has to beat the market AND taxes AND transaction costs AND inflation to truly "beat the market". I think Billy and Pascal can do that, but most people can't do it on their own unless they use a fundamental approach, instead of a technical one.[/QUOTE]

I don't really understand the transaction cost problem. My position sizes are usually >$100K and I wait for 20-25% profits to be had. I time the market all the time and transactions costs are nil. If I trade 100-200 times a year my costs at $7 per trade is $700-$1400, much-much less than the profit on a single trade.

For those who trade ETF's and are not aware, many brokerages (Charles Schwab, E*TRADE, Fidelity, Firstrade, Interactive Brokers, Scottrade, TD Ameritrade and Vanguard) offer free ETF trades: [URL="http://etfdb.com/type/commission-free/fidelity/"]http://etfdb.com/type/commission-free/fidelity/[/URL] Fidelity offers free trades for our friendly Robot ETF ... IWM

Fidelity Roth IRA + IWM Robot = tax and commission free trades!

Harry,

Do be sure to check for short-term trading fees with any commission-free etf program, which may be assessed if the fund is held less than a specified period of time (usually 30-days). There are also no-transaction fee mutual funds at many firms, but the transaction fee will be assessed upon not meeting the holding requirements, too. The cutthroat nature of the brokerage business has dramatically decreased commission costs and simultaneously improved many platforms, and that seems overall beneficial for retail customers, though.

Best,
Eric

Condition Bear Market Rally
S&P Target 1020
Small Portfolio IAU & XLF 17.80%
Hedge XLU -1.21%

Position Date Return Days Call
GCI 7/14/2011 19.33% 256 Hold
CSGS 10/3/2011 24.60% 175 Hold
NLY 10/25/2011 2.84% 153 Hold
DD 10/27/2011 17.46% 151 Hold
KBR 10/27/2011 26.01% 151 Hold
VG 10/27/2011 -32.52% 151 Buy
TTM 11/30/2011 59.95% 117 Hold
BT 1/4/2012 17.76% 82 Hold
PDLI 3/7/2012 5.91% 19 Hold
CLF 3/19/2012 -1.71% 7 Hold

S&P Annualized 6.45%
Small Portfolio Annualized 21.67%
Mousetrap Annualized 24.00%
Hedged Annualized 22.53%

Took awhile, but the money flow now favors bearish sectors. Could be a false signal and it could cancel tomorrow – but at least today, for the first time in five months, the money flow is indicating a pullback.

I mentioned the other day that Len was looking for a pullback as well.

Doesn’t really affect me either way, since the Mousetrap is hedged with a short position in utilities (XLU). Granted, utilities are somewhat ambivalent for a short, but they’ve behaved rather well thus far.

Generally the reason why there are double tops and bottoms in the market is because institutions have to sell and buy as they rotate between offensive and defensive sectors. If the market is going to go down, it’s best to be in something like utilities. But in order to move to a defensive sector, you have to sell the offensive sector first to raise cash. Hence a dip like Friday with selling offensive sectors and a pop like today buying defensive ones.

You’ll note the model is still short utilities, so there is still no indication for a massive pullback – yet.

No need to make any changes to the positions, but this is a good place for a… hiccup… in the market.

Don’t get faked out by the 1020 target I have listed for the S&P. That’s still residual from last year, and I’m waiting for a new bullish target if we get a little pullback to clear the air for a fresh reading. As I said over the weekend, jumping in and out of a bunch of stocks is a fool’s errand unless one has a model FAR more sophisticated than mine. Better to hedge when needed and rely on fundamentals to do the rest.

Tim

[QUOTE=ericoleman;21526]Do be sure to check for short-term trading fees with any commission-free etf program, which may be assessed if the fund is held less than a specified period of time (usually 30-days). [/QUOTE]

Thanks Eric. Fidelity's 30 Commission-Free iShares® ETF's (including IWM) have no commissions or short-term trading fees: [URL="http://personal.fidelity.com/products/funds/content/WhatYouCanBuy/exchange_traded_funds.shtml.cvsr"]http://personal.fidelity.com/products/funds/content/WhatYouCanBuy/exchange_traded_funds.shtml.cvsr[/URL]