Market Timing vs. Stock-Picking - Weekend WisdomFriday, November 23, 2012
Let's face it. Buy-and-hope is long dead. We sail in a new ocean where central bank whales prop up markets and economies on one side. And high-frequency sharks rip stocks back and forth for short-term gain on the other.
Is there a way to survive in these waters? I think there is a strategy that can give you high confidence and solid returns for a part of your trading portfolio -- without the headaches and heartaches of single stock blow ups. Let's look at the challenge, and the new opportunity.
3 Major Reasons Stock-Picking is So Hard
Before we get into specific hazards of trying to beat the proverbial monkey throwing darts, let me share a set of simple market truths I've honed down to two sentences:
It is possible to beat the S&P 500 (the market benchmark) because of stock-picking skill (and luck), and the fact that the index never takes a profit.
But, it is difficult to beat the S&P 500 because of stock-picking mistakes (and company blow-ups), and the fact that the index never takes a loss.
1) Your Stocks Have Company-Specific Risk
The seduction of being a stock-picker is finding those one or two dozen companies that crush the market with 25, 50, even 100% price appreciation. It's also one of the harder games in town.
There are many reasons most portfolio managers, including actively managed mutual funds and hedge funds, don't beat the market. I just shared with you the double-edge sword they wield in search of double-digit returns. As you can see, possible doesn't make it probable.
And with thousands of companies to choose from, how do you know you can find enough of the big winners to make up for the inevitable big losers? The market ocean is full of public companies dealing with "unknown unknowns" like surprise regulation, new competition and accounting fraud.
2) Your Stocks Are Anchored to Market and Sector Movement
No matter how great the company is that you own, no matter how superior its earnings growth and outlook, when markets tank, so do these strong stocks.
Just think of the three market corrections in each of the past three years. The bull market has remained intact, and I'd bet even the fundamental earnings picture for some of your favorite companies did too.
If you were smart and swift, you likely saw the recession-fear downdrafts coming and were able to sell high and buy back lower. But that is always a psychological battle too. When your favorite stocks are already down 5-10%, do you sell then and hope you can buy them back lower?
Even sector gyrations can turn value stocks into perpetual bargains. Just look at the moves in Energy and Technology this year. Some value stocks became even cheaper as these sectors make their big swings and a few big names were the cause of the irrational moves.
More . . .
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3) Your Stocks Get Tarred and Feathered by HFTs and Dark Pools
One of the most brutal realities of today's markets is that swing trading has been taken to the nano-second extreme by hedge funds, High-Frequency Trading (HFT) houses, algo shops and pro short-sellers. Their only goal is to make money short-term off of investor fear and greed.
They don't care about fundamentals, earnings or growth. They simply prey on the emotional nature of markets and drive stocks up into earnings/company news events, only to rip them lower once the results are out. And "dark pools" are where the big volume can happen, before you know what happened.
3 Reasons Market Timing with ETFs is Easier
For active traders, a great new alternative exists to gaming the short-term swings of individual stocks. Timing the market has just become easier and more precise with a flood of new ETF instruments. Here are three ways they can help boost returns for a part of your portfolio.
1) Capitalize on the Emotional Swings in Indexes and Sectors
Sometimes you can just tell when the market is headed for a sell-off. But when you own a stock for sound fundamental reasons that you took time and effort to carefully evaluate, it's hard to let go. We are creatures who get attached to our ideas, and our stocks.
What can you do? One simple and immediate way to detach and get focused on what the market is actually doing is by applying a balanced ETF strategy that allows you to sell short the market and even specific sectors.
Decide to keep your stocks if you want, but at least you'll have some exposure to the sell-off that hands you profits -- while others speculate with expensive put options, or simply worry and wonder. The confidence you gain from timing these short-term swings can do wonders for your portfolio, especially when you learn to buy extreme pessimism and sell extreme optimism.
2) Bet Heavy or Light Based on Price and Conviction
What if you see a big move coming to the upside, but you are not sure which stocks are the best to be in? This is another market situation beautifully made for ETFs.
By buying index and sector ETFs, especially those with 200% and 300% leverage, you can catch the move quickly and efficiently without wasting time on stock research.
And by zeroing-in your bet to capitalize on the strongest sectors - whether it's Retail, Biotech or Financials - you can easily make 10-15% on a 3-5% move in the major indexes.
When the timing signals line up to go long or short, having an arsenal of ETFs for the job where you know their important price levels is the key to conviction and position-sizing.
3) Use Leverage with Less Risk in High-Volume Instruments
Some investors and traders are afraid of double and triple leverage ETFs. The fear is understandable when you look at the volatility and daily range swings these instruments are capable of.
But the thing to keep in mind is that these ETFs are still based on an index or sector which isn't going to zero, like an individual stock can. And this also means that their returns will not only gravitate around the index or sector, they will participate in the ebb and flow of the markets.
One caveat: you have to be choosy about which ETFs to use from the hundreds available. Some are not liquid enough, or are based on faulty structures that make them vulnerable to manipulation or collapse.
Bottom line: If your timing skills are better than your stock-picking skills, you can beat the market with index and sector ETFs - and a healthy dose of safe leverage.
How to Find the Best ETFs for Playing Swings
Actually, whether the movements are upward or downward, you can profit by blending technical and fundamental principles (particularly the Zacks Rank). That's the premise behind our new Zacks Market Timer, a unique approach to predicting quick, explosive swings in industries, sectors and the market as a whole.
Of course, we won't call them all correctly, but our strategy is to cut short losses and maximize gains by 2X with a simple Zacks metric and then 3X again with a twist on a common investment move. If this sounds interesting, I encourage you to check it out right now. This service closes to new investors this Monday, November, 26.
Kevin, a Senior Stock Strategist at Zacks, is a recognized authority in global markets and renowned for predicting market swings. A former market-maker in the $4-trillion-dollar-a-day world of interbank trade, he developed the ability to track the movement of money, and trained his reflexes to take advantage of it. Today he directs the new Zacks Market Timer, providing commentary and recommendations.