Cognitively Yours 1.5

 

Raja R, Author

"Market timing is easier said than done and more difficult to repeat again and again"

In the previous blogs, we discussed how mental shortcuts though needed to take quick decisions may also lead to biases which result in sub-optimal investment decisions. We had also seen how fear of regret affects our decision to invest and makes us focus only on risk and not on returns. We had also discussed how impatience and need for instant gratification make us hardwired to short-term results. How the bias for action leads to not allowing investment to settle and yield rewards. In the world of investing, being correct and something isn’t at all synonymous with being proved correct right away. In the last one, we had seen how we over- react or under react to new announcements or events without incorporating the same in the information already available and not take a holistic view.

We have seen the equity markets being highly volatile last year. S&P BSE Sensex touched below 26000 level in the last week of March 2020 and the current levels are almost twice that of the low levels. Had someone invested even in an index fund then, the investment would have almost doubled in a period of less than a year. In hindsight, the investment looks lucrative. Is it really possible to time the market and get superlative returns? When the markets are in a downward turn, is it possible to exit and come at lower levels to enhance the returns? How many retail investors benefited from the volatility last year?

Let us understand market timing with the help of a text book problem in statistics.

Suppose you sit in front of two lights (one red and one blue) and is told to predict which of the lights will be flashed on each trial and there will be multiple of such trials. The experimenter has actually programmed the lights to flash randomly, with the provision that red light will flash 70 per cent of the time and the blue light 30 per cent of the time. In 100 trials, if the subject switches between red and blue, he will get 70 per cent of 70 those 70 trials and 30 per cent of 30 trials correct which will be 49+9 =58 trials. Had he stuck to predicting red light it would have been 70 per cent.

Predicting markets or human behaviour with some accuracy often involves accepting error in order to reduce error, that is better prediction by relying on general principles but acknowledging that we cannot be right in every single case. An effective strategy need not be effective in every single instance.

"Market timing is easier said than done and more difficult to repeat again and again. However, there are a few things which can be sure, and this is one - extreme market behaviour will reverse. Those who believe that the pendulum will move in one direction forever or reside at an extreme forever, eventually will lose huge sums. Those who understand the pendulum’s behaviour can benefit enormously."- Howard Marks