Experts believe that most people cannot tolerate a system that decreases their investment capital more than 20%. Your tolerance and ability to accept risk should help you classify a stock market timing system that’s right for you.
Irrespective of investment discipline you use, there are actually three important variables for evaluating your success – peak-to-valley drawdown, beta, reward/risk ratio. The first and key factor is your measure of risk. Performance volatility is a measure of the variability of an investment’s rate of return.
Explicitly, it is the standard deviation of the sample set of monthly returns that have been observed for the investment over the interval being considered.
1. Peak-to-valley drawdown
A modest approach to measure a good stock market timing system is to calculate the largest peak-to-valley drawdown that has or would have happened in the last five years. This drawdown is actually your measure of risk.
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2. Beta
Beta is an important variable that measures portfolio or timing system volatility as compared to an index. Most Betas are calculated based on the S&P 500 index. A beta of one conveys you that the system has the same volatility (i.e. risk) as the S&P 500 index. A beta of two conveys you that the system has twice the volatility as the S&P 500 index.
By dynamically managing your money, your stock market timing system should allow you to reduce the beta of your portfolio as compared to the index you are trading and considerably improve your returns over time.
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3. Reward/risk ratio
Reward/risk ratio calculates your reward as compared to your risk. In order to calculate this, you actually have to know your average rate of return. A rule of thumb is that your return should be at least twice as large as your risk.
Let’s say, your largest peak-to-valley drawdown percentage over the last five years is 15%, then your average rate of return should be at least 30%. In other terms, your reward/risk ratio (30%/15% = 2) should be 2 or greater.
You have to keep it in mind that the best stock market timing system for you will in most cases depend on your behaviour, specifically your tolerance for risk. You might think a trend timing system that averages 80% is a great system, but then again what if we told you that system had a risk potential of 35%?
Experts believe that most people cannot tolerate a system that decreases their investment capital more than 20%. Your tolerance and ability to accept risk should help you classify a stock market timing system that’s right for you.
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There are only a few systems accessible that really work. When evaluating a stock market timing system, it is essential to consider all of the factors discussed above and comprehend whether or not the system has endured and thrived over at least a five year period. If they’ve made it through the last five years, you’ve likely found a decent stock market timing system.
Disclaimer
This information is for Learning purposes only. We are indeed not financial mentors. It should not be considered legal or financial advice. You should consult with a financial advisor or other professional to find out what may be the finest for your individual needs and risk tolerance.
Please do your own research.
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