Markets move in cyclic trends: extended ups and downs, as well as sideways, recurring in similar patterns. Short- and medium-term trends last days and weeks, while long-term trends (that encompass shorter trends), last months and years. Long-term up trends are called bull markets, while long-term down trends are called bear markets. Shorter term down movements in a bull market are called pullbacks and corrections. Such shorter reversals against the trend also occur in bear markets.
There are a number of metaphors that can describe the nature of trends: ebb and flow, waves, pendulum swings. Trends are to a great extent rhythmic, cyclical and inevitable, because of the cyclical nature of the economic laws of supply and demand, overbought and oversold market conditions. With proper technical analysis tools (indicators), overbought and oversold conditions can be identified and measured, thereby forecasting with a high degree of accuracy the start of a new trend (reversal).
It is logical, then, if one can reliably identify these up and down trends, to be in the market (long positions) when the trend is up and to be in cash or short when the market trend is down. Buying and holding the conventional way for the long term, through both ups and downs, can be unprofitable and even disastrous. This is because much of what is gained in up movements is lost in down movements, and often takes a number of years, if ever, to recoup the losses. At best going through up and down markets without moving out of the market for safety is like treading water, "preserving capital," barely keeping up with inflation and making very little or no profit.
Many investors, because of the huge losses they suffered in the bear markets of 1999-2002 and 2007-2009 have become disenchanted with investing and with their investment advisors. Out of fear, many investors in recent years have decided to completely stay out of the market, missing out on highly profitable bull markets.
If one truly understands trends, one can be in the market when it has momentum and is moving in a trend, and be out safely when the trend reverses. Over an extended period of time, with the power of compounded returns, investment returns can be quite stunning.
This approach is called market timing--timing buy and sell positions with the up and down movements of the market. Most conventional financial advisors say active portfolio management and market timing doesn't work. It's true that most actively managed funds (mutual funds, hedge funds, endowment funds) and portfolios do not beat the market and actually underperform buy-and-hold passive investing in an index fund. Most market timers monitored by tracking services also do not beat the market. But because there are so many market timing systems with a few that do show success, it is wrong to paint all market timers with a broad brush and say that market timing doesn't work at all. Some market timers, not in the majority to be sure, have verified track records that substantially beat the market and are superior to any buy-and-hold methods of investing.
Combining trends, index funds and timing:
Timed Index Investing >>>
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