Thursday, April 19, 2007

The Importance of Time Horizons

Tim Price at The price of everything has an excellent post up today with the title, “It’s About Time...” In it, he quotes Jim Leitner of Falcon Management as saying (in Inside the House of Money: Top Hedge Fund Managers on Profiting in the Global Markets) that “If all investors allocate money to a one-month time frame, by definition there are going to be fewer opportunities there...There’s just too much competition over short-term trading, which is a timing-driven business. With timing, sometimes you’re going to be right and sometimes you’re going to be wrong, but it’s not going to be consistent over time. Meanwhile, the longer-term opportunities still exist because there hasn’t been that much money allocated with multi-year lockups. That’s not happening yet and probably won’t because investors are way too nervous and shortsighted.”

I talked a little about time horizons in A Sentiment Primer, and will have more to say on the subject at a later date, but I today want to note that I don’t believe Leitner picked the one month time frame for his hypothetical out of thin air. Given that the SPX is a real-time pricing measure, the VIX looks out 30 days, and VIX options extend all the way out to the middle of 2008, this presents an interesting context in which to think about risk and reward.

Later in the same article, Prices cites Nicholas Nassim Taleb (whose Fooled by Randomness is required reading for all VIXophiles) as the source for the statistic that the day trader’s portfolio has a 50.17% chance of improving for each minute that the frenetic trader checks the balance, while the long-term investor who checks his or her portfolio once a month is likely to see a gain in the period 67% of the time.

What is your time horizon? Do you always trade in the same time horizon? How good are you at matching your research, thinking, setups, entries and management of existing positions to your target time horizon? Do you know the time horizon of your favorite indicators? Do they suit your trading style and typical holding periods?

I'm not sure about the answers to all these questions, but I wanted to pose them as a thought experiment. I will kick them around a little more and weigh in again at some time in the future.

3 comments:

Anonymous said...

Hi, The market is hitting new highs while the VIX is still above the Feb lows. What do you make of this?

Robert L. said...

I found this interesting as well.

Looking at the 5 day VIX charts would lead one to believe that increased short term VIX readings are possible if we have another record setting day in the market with a higher corresponding reading on the VIX. IMHO. Indicative of traders wanting to take greater risk for gain while simultaneously recognizing that risk is back and planning accordingly.

Bill, your take?

Bill Luby said...

Great questions, guys.

I keep coming back to the difficulty in comparing an oscillating index like the VIX, with a trending one like the SPX.

I'll put up a post on this subject tomorrow, but right now I'm looking at a monthly chart (weekly would probably work a little better) of the VIX and SPX going back to 1990. The most interesting part of the chart is from about October 1994 through March 2000, which, of course, was a raging bull market in which the SPX increased by a multiple of about 4.5x. What many may not realize is that the VIX was moving up steadily during this period as well, going from the 12-14 range to the mid-20s.

The bottom line is that over time the SPX goes up about 10% a year and the VIX goes sideways, so there will be many bullish periods where the VIX actually goes sideways or rises. Only during extreme bullish complacency should we expect to see VIX readings in the 11-12 range and sub-10 may turn out to be a once a decade phenomenon.

In the current phase, I think echo volatility plays a strong part as well.

This is a subject I should be talking about a lot more; thanks for the nudge.

Cheers,

-Bill

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