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How timing the markets can fetch better returns

May 12, 2010 10:21 IST

Should long-term investors try to time entries and exits? Even in an idealised case, where two people make exactly the same decisions buying and selling the same stock on the same day, very different returns can result.

For example, suppose that a stock has a daily high-low range of 3 per cent. It trades in a range of 97-100 on a day when two people buy. On a day they both sell, it ranges between 194 and 200.

One trader gets the best possible price, buying at the low (97) and selling at the high (200). The other gets the worst, buying at the high (100) and selling at the low (194). The 'best' trader makes 106 per cent while the 'worst' makes 94 per cent.

Volatility differs for individual stocks and for different time periods. But it's a 'free shot' to time the trades once you have decided to buy or sell a given stock. If it doesn't work, no harm done. If it works, the return is higher.

The same logic extends to the broader market. The next financial year should be good for corporates. The third quarter (Q3) and Q4 results confirm the economy is growing fast and real interest rates (ex-inflation) are low or, perhaps, negative at the instant.

Investment in a Nifty fund or Nifty-correlated stocks at current levels should yield reasonable returns over two-three years. But first, what are "current levels"? In the past month, the Nifty has ranged through a high-low range of 5,000-5,400.

Monday's closing values of 5,193 were midway between this range. The high of 5,399 in early April was the best since February 2008.

Assuming the bull-market stays in force, the previous 2010 trading lows of early February (4,675-4,725) will not be violated. In fact, the 200 day moving averages (DMAs), which are between 4,885 and 4,970 depending on the method of calculation, should not be violated.

But the upper end of the 200 DMA range was tested last week. It may be tested again. That would require a roughly 150-200 point decline. While remaining overall bullish, it's a calculated risk for a long-term investor to wait for another two-three per cent decline to below 5,100.

There are several warning signals that will tell you if waiting is unlikely to work. One is a close above 5,320 on high volumes. That will suggest the market is set to surge beyond 5,400. A second will be concerted buying from domestic and financial institutions.

In either of those cases, you'll aim to get in at 5,300-5,350. The potential gain on the wait is about the same as the potential loss. But, in current volatile conditions, another downtrend seems a little more likely.

The author is a technical and equity analyst.

Devangshu Datta
Source: source
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