In search for returns on the stock markets, there are various strategies to reach the goal. The right moment to enter or exit the market plays an important role.
- Buy-and-hold is a popular investment strategy
- Timing strategies can provide more return with less risk
- Dual-mometum strategy can protect against emotional decisions
Those who try their luck in the stock market strive to increase their investments over the long term through returns. There are various investment strategies to reach their goal. Especially for small investors who may not have extensive knowledge of the stock market, the so-called buy-and-hold strategy is certainly an option. This means that shares in a company are purchased and then held over a long investment horizon of ten to twenty years until a decent return has been accumulated. It is a solid strategy that also yields profits relatively reliably. However, this buy-and-hold approach also has its pitfalls. It only works well if you do not touch your investment in the long term and can therefore sit out any weak phases in the market. However, if there is high volatility, as in the current market environment characterized by the corona crisis, other strategies can be far more efficient and at the same time lower-risk.
Entry point important even with buy-and-hold approach
As history shows, it is also important when exactly an investor enters the stock market. If you enter the market at a time when prices are very high and a crash follows unexpectedly, as in the 1930s, for example, it can take decades for a stock to regain its cost value – not to mention returns. Now, of course, there was also a crash on the stock market in the course of the Corona crisis, namely in March 2020, yet many of the most important global indices have already found their way back to their old heights and beyond. Accordingly, anyone who believes that the worst is behind us is disregarding the high degree of uncertainty that still prevails. Added to this are the sometimes dizzyingly high valuations on the stock markets, which in some places suggest parallels to past bubble times.
Experts therefore believe that investors should prepare themselves for lower returns on the stock markets in the coming years. Those who nevertheless want to continue to make profits with stocks could consider a different strategy than the established buy-and-hold approach. For investors with a little more background knowledge of the stock market, a timing strategy is an option, although it is not entirely uncontroversial among stock market experts. Finding the right moment to enter or exit the stock market is an art in itself. Some investors rely entirely on their gut feeling, which of course involves a high risk.
Timing approaches as possible yield drivers
However, there are also timing approaches that can be used to strategically find the points in time at which to leave the market or remain in it. Here, various momentum approaches have proven particularly useful for small investors who want to put together their own strategy. There are two strategies that are often combined into one – relative momentum and absolute momentum. While relative momentum looks for a stock that has outperformed its peers over a period of 3 to 12 months, absolute momentum is about finding stocks that have risen sharply over 3 – 12 months.
How such a so-called dual momentum approach could look concretely, as example with the combination of two market wide indices, each of which can be acquired by investors through an ETF. On the one hand, the Nasdaq 100 was selected as a technology-heavy U.S. index; on the other hand, there is the S&P Europe 350, which focuses more on long-established, traditional European companies.
In order to find the right time to enter and exit the stock market, an investor could now consult the performance of the Nasdaq 100 over a period of 10 months to find out whether it has been positive or negative. If the index is in the plus, the investor buys shares, if the stock market barometer is in the minus, it is time to get out or to bet on cash. This decision is repeated at regular intervals, for example always at the end of the month. The Nasdaq 100 thus relieves the stock exchange trader of the decision to enter or exit the market.
Now comes the decision, if buying is possible, which of the two indices should be bought. Here the investor again looks at the performance of the two indices over the past 10 months. The one that is doing better is added to the portfolio, the other one stays out. And so the stockbroker makes a new decision every month, always taking the two indices as a guide. This is what a dual-momentum strategy could look like. The past shows that this approach can also outshine the tried-and-tested buy-and-hold strategy in terms of returns. While the dual-momentum strategy could have increased your investment ninefold over the past 20 years, a simple investment in the S&P 500 could have increased only slightly less than fivefold over the same period – and with higher drawbacks at times.
Zero emotions
Of course, this is not to say that this timing strategy is a sure thing, but the approach is interesting for investors because the decision to enter or exit is not made on an emotional basis, but simply in light of market conditions. Because even though it should be clear to most retail investors that they should not be guided by emotions when making investment decisions, in reality it often looks different.
Two factors come together here: On the one hand, the so-called disposition effect ensures that investors tend to wait too long before selling a share certificate when losses occur, in the hope that the losses will be made up over time. On the other hand, profitable shares are usually sold again too early. The background to this is the fact that most people tend to shy away from taking losses. Red omens therefore hit investors more clearly on the stomach. Nevertheless, there is the additional effect that once losses have been made, further losses are perceived as less bad. So it makes less difference to a stock exchange trader whether he loses 1,000 dollars or 1,100 dollars. However, it does matter to him if he loses 100 dollars instead of losing nothing at all.
It is therefore important, although not easy, to detach oneself from these feelings and to look purely at one’s own expectations of a share. What return should the share bring with reference to the fundamentals, analysts’ opinions, market conditions? Here, too, the motto is that the portfolio should be monitored at regular intervals. With a clear goal in mind, it is then easier to let go of losing stocks and hold on to winners.
