Stock Investing -- Buy and Hold vs, Timing

The most important factor in stock market success is controlling risk. Risk, of course, includes not only the possibility that you will lose money, but also the possibility that you will miss out on a chance to make money.

The Sensible Stock Investor uses a variety of methods for managing risk. One of these is timing. Timing means selecting the optimum point in time to make a transaction--to buy or to sell.

Much stock investment literature derides timing as a risk-control measure. Most advisers focus solely on asset allocation and diversification. For example, whenever you see statistics about how much of your money you ''should'' have in large-cap stocks, small-cap stocks, bonds, cash, etc., the recommendations are based on long-term performance statistics for those asset types. In other words, the advice is always based on the presumption that you will Buy and Hold each asset. That underlying premise is almost always unstated. The use of timing as an additional way to control risk is ignored or criticized as impossible.

However, to the Sensible Stock Investor, timing--that is, not Buying and Holding everything--is a valid risk-control technique. It turns out statistically that not being invested in stocks when they are going down contributes much more to positive returns than being fully invested all of the time.

Timing can be used in both buy and sell decisions. It helps determine when to purchase a stock (thus reducing the risk that you will miss out on a chance to make money on the stock), and it also helps determine when to sell it (thus reducing the risk that you will lose money on the stock). Even Warren Buffett--who is reflexively associated with Buy-and-Hold--practices timing. There are many times when he holds a great deal of his assets in cash--waiting for the right time to buy.

Therefore, timing is a tool in the toolkit of the Sensible Stock Investor to practice risk management. It does not fully control buy, hold, and sell decisions, but it does influence them. The idea is to have more of your money in the market when there is a greater chance for gain, and to have less invested when there is a greater chance for loss. The whole idea is to stack the odds in your favor as much as you can. Timing helps you do that.

Timing is based on ''indicators.'' Indicators are simply pieces of information that may be predictive of future performance. Thus, they are signals whether to buy, hold, or sell. We'd like to be more fully invested when the market is going up, and less fully invested--or entirely in cash--when the market is going down. Indicators can help us toward that goal.

Because individual investors cannot spend all day studying the market, the best indicators for the individual must be (1) readily available, (2) free, and (3) easily understood. It turns out that we can find such indicators without too much trouble.

For example, we can employ indicators such as broad market trends, broad market valuation, individual stock trends and valuations, economic trends, and interest rates. It turns out that a straightforward set of such indicators can be obtained for free, put together in a logical fashion, and kept up to date with relatively little expenditure of time and no expenditure of money. The result is called a ''Timing Outlook.''

The Sensible Stock Investor then uses the Timing Outlook to influence--but not totally determine--his or her decisions about when and whether to buy, hold, or sell particular stocks. The Timing Outlook is used in conjunction with the other tools of Sensible Stock Investing. The whole toolkit--selecting excellent companies, valuing their stocks, maintaining a well-rounded portfolio, using sell-stops, and so on--creates a sound latticework of complementary techniques. These techniques lead to superior results, principally because they help you to manage investment risk.

A word about psychology: The Sensible Stock Investor creates all his or her tools as objectively as possible--when he or she is thinking most clearly, not in the heat of a fast-moving market. Psychologically, it can be hard to follow any system which is giving a seemingly non-intuitive signal. But that's why you have a system in the first place: So you can follow it when objective thinking is most difficult. The Timing Outlook helps take emotions out of the equation. That's a good thing, because in finance and investing, emotions often point in the wrong direction. Level-headedness usually wins out.
by DVK Group, Inc.