A crucial investing question: Do you know your time frame?

A crucial investing question: Do you know your time frame?
Barry Ritholtz,
Washngton Post March 24 2013

Do you suffer from time frame confusion?

That question came up recently when I was asked about a specific stock. Although we did not own that stock, I discussed why its sectors (health care and biotech) had been doing well in recent years — and would probably continue doing well. It has been part of our long-term view that these industries will thrive in the coming decades.

But this particular name had just run straight up, Apple-like, and I mentioned that in the short term, it might be due for an Apple-like pullback as well.

Subsequently, an investor asked, “You mentioned the stock was overbought and could pull back, so how does that square up with your long-term view that this stock and sector can do well?”

Short answer: It doesn’t.

Longer answer: Never confuse investing with trading. The short-term swings in prices are mostly noise; volatility is often a reflection of traders’ emotions. Longer-term price changes reflect earnings and valuation.

Hence, if you are saving for retirement, the fast in-and-out trading is irrelevant. Our clients’ investment profiles are typically looking out many years and decades. What a stock does over the next 30 days is essentially a trading question, and irrelevant to them.

Whenever you hear a discussion about the short-term swings in any given stock’s price, your immediate thought should be whether it matters to why you are investing. Consider what your time frame is and you will figure out what your answer should be. Indeed, much investor confusion and quite a few investor errors involve making the mistake of investing for one time frame and behaving in another.

Perhaps a few examples of shifting time frames might help illustrate this.

A classic trading rule: “Never turn a trade into an investment or an investment into a trade.” A trader’s goal is to take advantage of the volatility of daily price fluctuations to earn a short-term profit. This is a defined holding period (i.e, before the market closes that day; 48 hours, etc.). A trader who extends this into a longer frame — usually because the trade went against them — is making a classic time frame error. How many traders who shift a trade into an investment have done all of the requisite research, thinking and planning for a longer-term hold?

This reveals the shifting of time frames for exactly the wrong reasons.

Investors can make a similar mistake. They own something with an expected multiyear holding period, only to bounce the stock on some very short-term news — a critical review of a product, a negative research report, a 5 percent price drop. I doubt any of these investors has in their long-term plan “I will sell XYZ if an analyst downgrades the stock.” Yet that is what they do all the time.

Good investors must learn to contextualize the daily background noise. That is my phrase for the never-ending proliferation of economic news releases, media broadcasts, technical updates, and cable TV shows that are mostly meaningless time fillers. Television and radio have 24 hours a day to fill — does anyone believe that all of that content is meaningful? The Internet has an infinite number of pages to fill — guess how many are truly valuable?

Consider these various time frames, and what they mean to your investing or trading approach:

Minute-to-minute: A very noisy and constant flow of prices, rumors and chatter about stocks; this is the realm of day traders, Twitter and institutional desks. If you are an investor, nothing is more meaningless to you than this time frame.

Hourly: Similar to minute flow, only now we can add how the stock opens or closes. Traders can be heard to say things like “strong open in XYZ” or “I hate the way the ABC closed.”

Daily: Filled with random gains and losses, driven mostly by the overall market (my guess 35 percent) or the equity’s sector (about 30 percent). News flow often pushes prices in one direction, only to quickly reverse after a short period. Still reflects economic and other noise overall.

Weekly: Informative charts: Overall trend begins to show. Begins to smooth out the random movements. Noise factor considerably less. Good way to think about cyclical markets (i.e., two to five years).

Monthly: Provides a window into longer term, decade-long secular cycles. Most traders ignore the monthly charts — too slow, they say — but these can give you some insight into real (vs. false) reversals.

Quarterly: Valuation data comes into focus via earnings. A longer-term view allows potential mean reversion to be taken advantage of (via rebalancing).

Annual: For retirement planning and life events. Yearly data put the rest of the noise into perspective. Most of the weekly or monthly random up-and-down movements get smoothed out. Ultimately, this is where long-term investors should be focused.

Decades: The market historian’s friend.

What’s your time frame like?

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Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. On Twitter: @Ritholtz.