Equity markets tend to be cyclical: Positive periods are followed by negative periods, which are then followed by positive periods.
It’s therefore common to ask whether it is possible to time investment decisions to sell at the peaks and buy back at the troughs?
Should I analyse data?
One way to do this might be to analyse forward-looking information such as economic and corporate data and make predictions about the direction of the markets – but it is hard to make predictions, especially about the future.
Another approach might be to look back at data from previous cycles and identify patterns that could be repeated going forward.
Recent research by Dimensional Fund Advisors did exactly this, running almost 800 tests on data from 15 world equity markets to identify signals that might point to a change of market cycle and simulating the trading activity that might improve investment returns.
Most of the 800 tests failed and resulted in worse performance than would have been achieved by just going with the flow of the market. But some of the tests worked and produced positive performance results.
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You might think this is good news for investors—that they can replicate the trading patterns suggested by the positive tests. Unfortunately, the number of positive results was no greater than one might expect with such a large number of tests.
As the researchers explain, the odds of one person coin flipping 10 heads in a row are small. But if you asked 100 people to try, you would expect around five of them to be successful. The same proportion of the 800 market tests were positive and the research was unable to determine if any of them were more than just a sequence of lucky coin tosses.
Ride out short-term market volatility
The conclusion of the research is that, on average, investors are better off sticking to their long-term investment goals and riding out short-term market volatility, rather than trying to time their trading to coincide with the peaks and troughs of the market. This is also the approach we advocate at volatile times such as these.
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Year to date (to 9th March as measured on a total return basis) our medium risk portfolio has returned around +0.5% compared with the broad UK equity market falling by around -1.5% Interestingly our portfolio dipped by 4% at its lowest point during this period, compared with the UK equity market falling by over 11% at its lowest point.
This post was written by Steve McGregor of the Private Client team. Get in touch with him to find out more about our investment strategy.
Update: The UK vote on the EU Referendum is certainly a great case study for the above! Check our our latest post on the topic “Investment after Brexit: What to do with your money”