Timing the Markets is a Fool's Errand; What Investors Should Consider Instead

It's understandable to be concerned about your investment portfolio in an environment where the rate of change is significant (higher than your reference point). From a behavioral perspective, making a conscious decision to be proactive, as opposed to reactive, can be beneficial. The alternative can lead to selling out of the market at or near lows.

The Certified Financial Planning community uses a helpful visual to illustrate:

Source: CFP.net

One of many fascinating behavioral elements endemic to capital markets is the fact that people tend to be most excited to buy an ETF, equity, or other security at or near a top. They are also most likely to sell at or near a bottom.

There are few, if any, other consumer markets where we display similar behavior. For instance, I recently attended an in-person conference and needed a new pair of shoes. I had my eye on a specific brand and style. A week passed, and the shoes were discounted, plus I had a coupon -- I ended up buying those shoes for roughly 30% less than when I first spotted them. I'm not alone in rejoicing when I find a deal like this; so why is it so hard for investors to see it the same way when it comes to investing?

In fairness, U.S. equity indexes could be further discounted. Furthermore, timing markets in the short term is difficult. In the long-term, it’s next to impossible. Translation: picking tops and bottoms consistently is a fool’s errand.

Insight

There’s incredible behavioral finance research available and it can change your perspective on (inevitable) market drawdowns. Daniel Kahneman’s Thinking Fast and Slow is an excellent starting point.

The author, with the help of Amos Tversky, earned a Nobel Prize for his research. There’s a point of emphasis on the two types of human thinking; referred to as System 1 and System 2. In brief, System 1 thinking is intuitive (fast, involuntary). System 1 is reactive. This ability keeps us functioning at a high level. We’re equipped to make 35,000 or more decisions a day. By contrast, System 2 thinking involves “complex computations and allocates attention to the mental activities that demand it.” System 2 is more proactive.

Daniel Kahneman would likely advocate for System 2 thinking when any capital allocation is considered. If a portfolio declines by 30%, our System 1 brain wants the pain to stop (quickly). The part of our minds capable of more deliberative analysis is necessary to fact check the more impulsive angle. The dichotomy between our “instinctual reaction” and our more reflective process is a challenge to reconcile.

In other words, we benefit from having a plan and sticking to it. In capital markets, call and put options afford end-users the ability to define their risk and potential reward (depending on the strategy) over a specific time frame. That’s powerful.

VOLQ Options

Nasdaq is excited to announce the launch of VOLQ options. The ecosystem that has grown up around the Nasdaq-100 over the past few decades is evolving. VOLQ options will enable market participants to express a view on forward NDX volatility and/or manage volatility (vega) risk.

VOLQ options can help market participants create a more “proactive” portfolio. The VOLQ Index and associated futures contracts exhibit a negative correlation to the Nasdaq 100® Index. Put more plainly, if the NDX declines, VOLQ would likely increase (and vice versa). In theory, owning VOLQ call options during a significant NDX decline could act as a P&L speedbump.

There’s undoubtedly nuance that needs to be understood before using VOLQ option strategies. Click here to learn more.

Looking Ahead

While past performance is not indicative of future results, the July trend is positive for the Nasdaq-100® Index. The charts below illustrate average monthly NDX returns since 2010 and then break out July performance by year. July is by far the standout from a monthly perspective. On average, between 2010 and 2021, the Nasdaq-100 Index has gained 4% during the month. 

July NDX returns since 2010 have all been positive. Four of the 12 July returns have been greater than 6%. The “weakest” July (2014) yielded a much more modest 1.18% gain. Will July 2022 buck the trend?

Source: Bloomberg, Nasdaq

Big picture, volatility is a constant. Volatility is the source of future returns. Volatility is one of those words where the denotation and connotation are unique. Volatility is best understood when placed in perspective. Derivatives allow us to embrace change. To learn more about the Nasdaq-100 Index and its index options ecosystem, explore here.

Nasdaq® is a registered trademark of Nasdaq, Inc. The information contained above is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. Neither Nasdaq, Inc. nor any of its affiliates makes any recommendation to buy or sell any security or any representation about the financial condition of any company. Statements regarding Nasdaq-listed companies or Nasdaq proprietary indexes are not guarantees of future performance. Actual results may differ materially from those expressed or implied. Past performance is not indicative of future results. Investors should undertake their own due diligence and carefully evaluate companies before investing. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED.

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