Monday, September 21st, 2020

Is Market Timing Dangerous in Late 2020?

August 24, 2020 by Jim Walker  
Filed under Options Trading Education

 

The stock market has made an impressive recovery while the Covid-19 pandemic worsens. Is market timing dangerous in late 2020 when the economy is so weak? This is an important question for options traders for whom accurate market timing equates to profitable trading.

Is Market Timing Dangerous in Late 2020?

Market Watch has posed the same question in their article quoting Warren Buffett about the clock with no hands.

‘They know that overstaying the festivities – that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future – will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.’

Buffet wrote this in a 2000 letter to Berkshire Hathaway shareholders in 2000. As he noted at the time, when investors make money too easily and with little thought, it reinforces the belief that simply doing more of the same will always be successful. Those who do realize that eventually the bull market will correct are always trying to time the market so as not to miss out on any late profits. But, is market timing dangerous in 2020?

The Mismatch between the Market and the Economy

A useful indicator of the rationality of the stock market is a comparison of the Wilshire 5000 Index and the GDP. The Wilshire 5000 is the capitalization-weighted index of stocks of US companies traded actively in the USA. Today it is based on only 3,473 stocks. It stands today at 35,050.10. The US GDP stands at $20.50 Trillion. Today the ratio is 1.26 which compares to 1.0 in 2007 before the crash the started the Great Recession and 1.18 in 2000 when Buffet made his “clock with no hands” comment prior to the dot com crash.

As giddy as investors seem to be about throwing money into the market, the Fed’s promise to go “all in” to maintain credit, and hopes for a vaccine-driven cue of Covid-19, there is a huge mismatch between the market and the economy.

Is Market Timing Dangerous in Late 2020

Stock Options for Uncertain Times

The nice part about trading options is that you can use put options to protect your gains, call options to take advantage of further price growth, and in both cases limit your potential costs or losses to the price of an options contract. Years ago we wrote about using a long straddle approach to take advantage of both upward and downward price action. With this strategy you will buy both puts and calls on a stock with the same expiration date. You only lose money if the price does not budge but your expenses are limited to the prices of the contracts. Considering the uncertainty of a market that is overpriced to and beyond the extent that it was prior to the last two stock market crashes, covering your gains with put options while trying to make the best of an irrational market surge would seem to be a good idea.

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