Mar 12

Is risk on / risk off just market timing in disguise?

The logic of investing is simple – buy when the market is low and sell when it’s high. But even the most sophisticated, experienced investors with all the data and research available to them find it difficult to do this consistently. That’s because investment markets are not only driven by fundamental factors like the economy and profits, but are also influenced by investors’ emotional behaviour.

When it comes to investing, many people are their own worst enemy. Fuelled by a desire for short term gains or the fear of losing money, they buy and sell at the wrong time based on emotional responses. These emotions are often triggered by events or noise that can exaggerate or misrepresent the facts, and are already factored into market expectations.

The current market conditions can be described as a “risk on/risk off” environment. This is characterised by the dominance of emotionally-driven factors over the traditional fundamentally driven arguments, and results in extreme short-term volatility and low levels of long-term confidence.

 

Changing the way we think

We’re in a world of heightened global geopolitical uncertainty thanks to unrest in the Middle East and the lack of political cooperation around resolving the problems facing the US and Europe. This has created strong headwinds that have hindered the outlook for global economic growth and economic prosperity. These elevated levels of uncertainty and confusion, combined with the continued political brinkmanship around the world, have led households and businesses alike to become significantly risk averse.

But it’s important to understand that financial markets aren’t perfectly synchronised to global or domestic economic trends.

Although markets will eventually return to the primary fundamental drivers of long-term performance and we shouldn’t lose sight of these factors, it is important to recognise the current drivers of market behaviour and adapt your investment strategy to take advantage of the opportunities it presents and the potential risks it imposes.

 

Timing has never been an exact science

If you’re going to try and pick the right time to invest in markets, there’s a lot of information you have to understand and analyse to get it right. In reality, you’ll never successfully pick the top or bottom of the market. So in a world that’s driven by so much sentiment and uncertainty, where assets that carry risk trade up or down irrespective of their fundamental valuation, you become a contrarian investor, i.e. you don’t follow the crowd, because being a consensus investor doesn’t take you anywhere.

To survive the turbulence and turmoil of financial markets today, you need to be nimble. Traditional market timing, in the context of a trading strategy, has more emphasis on the fundamental drivers of markets rather than indiscriminate risk on/risk off trading. Ideally you should take on some risk from time-to-time in a market that can offer you great opportunities. Then at some time in the future when there’s nothing but good news in the market, you offload some of that risk. But you do this in small amounts – the classic dollar cost averaging argument.
 

Maximising your potential success

Successful investing doesn’t come from accumulating cash and waiting for the right time to invest, nor from frantically trying to withdraw your money when times get tough. Dollar cost averaging, or regular investing, essentially averages the price you pay per unit of the investment and mitigates the risk of buying at the top of the market.

 

What this means for investors

• It is important to recognise that geopolitical uncertainty and social turmoil is now the norm rather than an exception, and it’s important to pay close attention to forces that shape the financial market landscape.

• During periods of high volatility and nervousness, financial markets offer unique opportunities to acquire assets that are cheap, attractive and of great value.

Always speak with your financial planner before making your investment decisions.

Source: Advance Asset Management Limited, December 2011

Newcastle Investment Advisors
 

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