Market Timing: Early is Not Always Better in the Stock Market

By Michael Cintolo, Chief Analyst, Cabot Growth Investor and Cabot Top Ten Trader
From Cabot Wealth Advisory 6/24/10 Sign up for free Cabot Wealth Advisory

One topic I like to write about every few months (partly to remind myself) is the principle that, in the stock market, early is not always better. Of course, this is the opposite of the usual wisdom (the early bird catches the worm, and so on), and it also doesn't jibe with most investors who (over)react to every wiggle in the market.

To these investors, it's all about being early—after all, if the market has bottomed, it's better to buy on the first or second day up than the eighth or ninth day up, right? In this limited example, yes; obviously, having identified the low, you're better off buying as close to the low as possible.

The only problem is, correctly identifying the low point is nearly impossible to do in real time. If we're talking about the general market, for every sustainable, multi-month low, there are dozens of days that are false lows, after which the market keeps on slipping. In other words, the only way to get in at the very bottom is to bottom fish during a downtrend ... but if you do that, you're going to be wrong many times before you finally catch a low. And the end result will be lost money!

Thus, the first lesson of "don't be early" is to always wait for confirmation of a new uptrend (or downtrend, for that matter). Market timing is not about being the first to get in at the bottom or out at the top; it's about correctly identifying the trend and riding it as long as it persists. Yes, that means you'll never buy at the bottom or sell at the top. But it also means you won't die a death of a thousand cuts (by continually trying to pick the bottom) or ever miss out on a major move in either direction.

I'm writing about this topic because of its implications for buying individual stocks ... something that is very timely given the current market environment.

A few years ago, I was trying to buy early like most investors. Now, I was never trying to pick a bottom, but if the market had a few good days (including a good gain on a volume thrust within a few days of a low) I would usually put on a couple of small positions and see how they did. I would do this even if our own intermediate-term trend indicator, the Cabot Tides, was still negative.

Now, realize that these volume thrusts tend to work pretty well at identifying a low, and they tend to come a week or even two before the Cabot Tides give a bullish signal. Thus, you'd think my results would be enhanced by buying a couple of stocks at this earlier stage, right?  

Wrong! I went back and studied my trades, and here's what I found: There were numerous stocks I bought on the volume thrust that turned out NOT to be leaders. They looked good initially, but eventually, they petered out and lagged the market.

Also, even among the stocks I bought that WERE leaders of the new advance, most didn't make immediate upward progress. There were a few exceptions, but the vast majority bobbed and weaved for a while before kicking into gear. Finally, of course, there were those times when the Tides never did turn positive, so most everything I bought turned out to be a small loss.

All in all, the study showed that, on balance, buying before the Cabot Tides Market Indicators turned bullish wasn't helping my results ... in fact, it was slightly hurting them!  Waiting for the Tides to turn positive—it usually takes two or three weeks after a significant low point—allows you to a) home in on the true leaders of the advance, and b) take out a little extra insurance that the rally is the real McCoy.

 More on Stock Market Timing Indicators

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