Don’t believe anybody that says that market timing is not an important element of successful investing. Timing is a crucial part of it – basically you have to know when to buy (identifying when the prices are low) and know when to sell (identifying when the prices are high). I have historically found it more difficult to know when to sell than when to buy, presumably because markets crash quicker and harder than they go up. I have been actively working on this part of my investment experience for the past few years. I still do not feel comfortable with my exit tactics.
It is a very, very frustrating part of investing when you know you had the timing correct, but were unable to execute on any trades. Two days ago, on May 25th, I wrote:
I am generally of the opinion that the markets at this time are greatly oversold, with presumably most of the selling done across the Atlantic Ocean in Europe by panicked investment bankers and hedge funds. Unfortunately (or fortunately), I am still looking for areas to safely deploy cash.
I had placed a smattering of orders, starting at roughly 3% below the May 25th market close, but they probably won’t be executed now since the markets seemingly have reversed. I wanted to get about 10% equity exposure to the fossil fuel industry and I only have about 5% exposure on the debt side. Since the whole Canadian crude market has skyrocketed in the past couple trading sessions, I’m going to have to re-evaluate the short-term entry or hope for one more shock-wave coming out of Europe (which would be nice). My general thought is that while I don’t believe in the “10% of your portfolio in Gold” inflation-hedging technique, I do solidly believe that having a claim to future cash streams from Canadian oil and gas companies with significant reserves will be a good capital preservation technique over the long run – at least until crude prices rise to the point of unsubsidized alternative energy production costs.
After describing my inability to execute on what should have been a short-term winning trade, now is the time for a trading lesson to describe why the process I employed is correct.
Whenever I place orders, it is always with limit orders, and broken into price increments that are scaled below the initial point. I very, very rarely buy at the ask and sell at the bid unless if dealing with illiquid securities and somebody posts something juicy.
As an example, if a share is trading at $10/share and I was interested in purchasing 1,000 shares and thought market volatility would take it roughly 10% below current price levels before bottoming out, a simple execution would be to break it into five branches, such as the following:
Buy 200@9.80, 200@9.60, 200@9.40, 200@9.20, 200@9.00
The total cost of the order, excluding commissions, would be $9,400; a lot cheaper than just putting in an order for 1000@10. However, the cost of such a decision is that you may not get your desired quantity (or any at all) if there is not sufficient volatility in the marketplace. In the case of my fossil fuel equity trades, this is exactly what happened – market volatility took the market price up and not down as I expected.
Inherent with the breaking of such orders is the assumption that you don’t know what “the bottom” will be. I have learned many times over that predicting the exact bottom is impossible and that breaking orders into smaller quantities is the best way to capture value from this admission.
Using a real brokerage (e.g. Interactive Brokers) keeps trading costs of breaking orders into small bite-sized amounts cheap; a price-making order on the TSX incurs around 52 cents of commission for 100 shares. The increase in commission is inconsequential to the likelihood of saving capital costs with the lower-priced purchases. Even using a less sophisticated brokerage, you can still obtain significant price savings.
This same heuristic can also be employed with an exit of a position.
Note that it is very easy to modify this into a workable algorithm. When working with institutional quantities (e.g. millions of dollars), you typically employ algorithms to randomly time entries and exits depending on ambient market conditions and the volume seen in order to get the best execution on the entire order. When working with large amounts of dollars, masking the intention of your order is critical in order to be able to successfully accumulate or distribute share holdings.
One major advantage a retail investor has over the institutions is the ability to get in and out of positions with the click of a mouse button, as opposed to employing complex algorithms to do the same over the period of days or weeks.