Market timing is attempted by many but trying to anticipate the short term direction of the markets is not only nigh on impossible, but should you succeed in missing the worst days you’re also likely to miss the market’s best.
What Is Market Timing?
Market timing is essentially the strategy of making ‘buy’ or ‘sell’ decisions on financial assets, usually stocks, by attempting to predict future price movements.
Market Timing Strategies
The most popular marketing timing strategies include the following:
Asset-class rotation: Selecting the optimal moment to switch between asset classes (stocks, bonds and cash), with a particular emphasis on downside risk control by drastically increasing cash holdings in anticipation of market declines.
Style rotation: Selecting the optimal moment to alter investment styles, such as a move from growth to value investing.
Sector rotation: Selecting the optimal moment to switch between industry sectors in the economy.
Individual security rotation: Selecting the optimal moment to sell or buy specific securities.
The last strategy is something that many investors do almost instinctively when deciding whether or not to purchase or sell shares. However, these strategies are almost impossible to actually put into practice successfully as you have to not only time your exits but also your entry points.
Does It Work for Some?
John Bogle, Vanguard founder and industry legend, expounds on this topic frequently, with comments such as: “...market timing is impossible. Even if you turn out to be right when you sold stocks just before a decline (a rare occurrence!), where on earth would you ever get the insight that tells you the right time to get back in? One correct decision is tough enough. Two correct decisions are nigh on impossible.”
Of course, you do hear about financial ‘experts’ who can perhaps predict one crash but they inevitably have their reputation tarnished by the tendency of markets to surprise and confound their predictions.
As Bogle has attested: “In 50 years in this business, I don’t know anybody who has done [market timing] successfully and consistently, nor anybody who knows anybody who has done it successfully and consistently. Indeed, my impression is that trying to do market timing is likely not only not to add value to your investment programme, but to be counterproductive.”
If even professional asset allocators can’t get it right—and research has shown that they frequently don’t—there is little chance of an ordinary investor doing so.
Risks
Worse, if you’re entirely out of the market when shares suddenly rise following a market crash, you can miss out on the superlative benefits that will follow when it bounces back. When the market does recover it normally rises quite quickly and unexpectedly.
Indeed, repeated studies have found that being out of the market for only a few days can dramatically reduce returns for an investor when the markets are rising. For example, over the 15-year period through to 2005, a buy and-hold investor in the S&P 500 would have realised an average annual return of approximately 11.5%. By contrast, an unlucky market-timer who missed only the market’s ten best days during that 15-year period would have earned an average annual return of just 8.1%.
Buy and Hold
What has proved to be a more practicable and very much more successful strategy than market timing has been to buy good shares cheaply—or good equity funds at a relatively low cost—and to hold them for the long term.
As American stock investor and author of Common Stocks and Uncommon Profits Philip Fisher sagely noted: “Short term price movements are so inherently tricky to predict that I do not believe it is possible to play the in and out game and still make the enormous profits that have accrued again and again to the long term holder of the right stocks.”
