My investing results this year have been excellent, but they would have been better if I had followed my plan and failing that simply held on to what I had. Instead I’ve been selling into this rally, as my Investormeter chart shows. My written and mental plan was to add exposure on the way up.  I don’t see the need for self-flagellation, and a retrospection based on any single point in time shouldn’t be given much weight, but I do see an opportunity to learn from what, at least momentarily, appears to be a mistake. Now is as good a time as any to ponder why I didn’t follow my plan.

Before I go on I’m going to re-read the following, as it speaks directly to my bias of selling early.

“The absolute price of a stock is unimportant. It is the direction of price movement which counts.”

“During major sustained advances in stock prices, which usually occupy from five to seven years of each decade, the investor can complacently hold a list of stocks which are currently unpredictable. He doesn’t worry about the top because he knows he is never going to sell at the top. He knows that the chances are overwhelming in favor of the assumption that he will get far better prices by waiting until after the top is passed and a probable reversal in trend can be identified than he will ever get by attempting to anticipate the top, and get out on the nose.

In my own experience the largest profits we have ever taken have come from stocks purchased while they were making a new high in a market which was also momentarily expecting the top. As I have already pointed out the absolute price of a stock is unimportant. It is the direction of the price movement that counts. It is always probable, but never certain, that the direction of the price movement will continue. Soon after it reverses is time enough to sell. You should sell when you wish you had sold sooner, never when you think the top has arrived. That way you will never get the very best price – by hindsight your individual transactions will never look daring. But some of your profits will be large; and your losses should be quite small. That is all that is necessary for a satisfactory, enriching investment performance.”

“Stock Profits Without Forecasting” by Edgar S. Genstein via http://www.raymondjames.com/inv_strat.htm

Why this retrospection? One of the few economists I follow, Jeff Miller at A Dash of Insight, posted a review of his predictions today. While I think I can lay claim to at least as bullish predictions during the market nadir and early days of this rally, it was Jeff’s closing comments layered on my earlier observation that the market was higher in September last year, that prompted this retrospection.

Many investors now worry that they have “missed the rally.” Here is something to consider. The market is still 10% below the pre-Lehman levels. This was a time when the market was expecting a recession, and some saw a deep one.

The situation is now different. There is a massive stimulus effort, with more to come. There are many problems, as we suggested. It is no longer a question of just “buying the market” but the story is not over. There is still plenty of opportunity for those analyzing specific stocks and sectors.

I have done a poor job of folding momentum into my investing strategy. That is probably due to my bias to be different. I dislike crowds, view the masses as fools and rejoice in travelling a different path in life. I also dislike definitive decisions and prefer an incremental approach. I prefer to gradually adjust my exposure to the market, rather than to wade in and out at specific points. Yet, in hindsight from recent events and thinking back to 1999 and the beginning of 2008 my results would have been better if I was able to listen more to momentum. There is little doubt in my mind that momentum investing has considerable merit, I simply struggle to fuse it with my own investing style.

My difficulty remains in implementing what sounds so simple, but is so very difficult to do in real time. That is “waiting until after the top is passed and a probable reversal in trend“. Looking back at charts the tops and bottoms always seems so obvious, but identifying them in real time is so very difficult to do. I’ve mentioned the Death Cross as a final indicator to get out and some market participants use the 200DMA crosses above the 50DMA as their signal.

Looking at the current chart of the S&P 500 which closed last night at 1092 the 50DMA is 1034 and the 200DMA is 908. While the 200dMA is moving up and will continue to do so even if the S&P 500 now went into a correction, it clear that a cross would be considerably lower than prevailing levels. While getting out sooner exposes investors to a nasty case of whiplash.

I’ve spent sometime this morning running various future price scenarios for the S&P and my conclusion is that it is very unlikely that waiting to see the momentum change from this point will result in better sale prices. Hence I’ll continue to stick to my averaging out plan. Here are two of the dozen or so charts I mapped out this morning. My point isn’t to try and predict the market path, but to see the likelihood of the death cross occurring at higher market levels.

I’ve waited patiently to try and recognise many market tops to enter short positions. By the time I’m sure a top has occurred and momentum is to the downside, prices are off by 15-20%. I’m then fearful that the correction is over and so don’t enter the short positions. In short I find this single decision point style of market timing incredibly difficult to implement.

As an overall observation, I find itchy feet and self doubt are often a precursor to vindication of a position. If anyone can suggest ways to fold momentum into my strategy or how best to spot market turns I’m all ears.

I’m not sure why I didn’t follow my plan. Looking back through my posts I clearly saw higher prices ahead in March, was positive in July and August, but clearly during April and May I was selling. Perhaps the reason I didn’t follow my plan was relief. Relief the rally occurred coupled with a self doubt that I was right and so many others wrong. At the time the bears seemed to get louder everyday and perhaps I was swayed by them. Still I’ve done alright and am now better prepared for my next major confrontation with the market.

One final observation. I approach investing from a ‘what would make me feel worse perspective‘. Would not participating fully in this rally or not having cash in the event of a major correction make me feel worse? I think you know the answer to that. My over-riding market belief is that there will always be opportunities to make money, it is ensuring you’re able to profit from them and avoiding losses that are more important. The duality of opportunity cost and Buffett’s rules number one and two. It is from that perspective that I argue the risk of covered calls is to the downside and not to the upside as many investors believe. Opportunities are plentiful, capital is scarce.

Thanks a lot to anyone who has read this self indulgent exploration. The other impetuous for this retrospection was these portraits of me which my kids did last night. Note the open and folded arms. I ask you, how can a dad not be introspective when faced with those images. Perhaps I should simply concentrate on the smile in both portraits. “Too often I embrace introspection and self-doubt. I wish I could embrace the good things.” Hugh Laurie.

Related posts:

1. Fusing Business Momentum and Value
2. Investometer 2009 Year End