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What you need to know about market timingon
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One fact holds true and has been for decades: there is a lot of money to be made in the stock market. But then, how you set about investing is entirely up to you. There are investors who specialize in “buy-and-hold” tactics; this is a strategy that involves buying a mutual fund, ETF or stock and holding it for a period that extends from the present far into the future.
However, other investors make use of a definitive strategy known as “market timing.” The goal of these investors is to take advantage of the short-term or temporary fluctuation of the stock market and make a lot of money within a short period.
Both strategies of making money in the stock market are not wrong; however, there are experts out there who claim that market timing, as an investment philosophy, is a terrible idea, especially over the long term.
Even though the chances or odds may be somewhat stacked against you when it comes to making a significant amount of money by following the market timing route, the fact remains that you can still make a substantial amount of money.
What is Market Timing?
Market timing can be said to be a strategy or approach that is employed when making crucial buy or sell decisions of stocks or other financial assets by making attempts at predicting future market price activities. These predictions are usually based on the position of economic or market conditions which result from fundamental or technical evaluation.
It involves moving in as well as out of the stock market by making use of what is known as “technical analysis.” Technical analysis includes studying the charts of specific companies and making investment decisions based on how the stock moves.
It could also mean taking a look at consumer spending, economics, GDP (gross domestic product) to make informed investment decisions.
But whichever method or approach you make use of is not too important; what is essential, however, is that you are always on the move, i.e. moving in and out of the stock market, trying to make a profit.
Is It Possible to Time the Market?
Now that you know what market timing is, let us take a look at some of the reasons why financial experts claim that this method of earning a profit in the stock market is not feasible.
Predicting the next direction of the stock market is somewhat tricky, and this is why some mutual fund investors who attempt to time the market usually fail in relation to investors that remain invested.
Another reason that a majority of these experts allude to is that run-of-the-mill investors do not have the time as well as the skill to be engrossed in timing the market. Thus, the likelihood of pulling it off over the long term is rather slim.
If you are a savvy investor or business person, you will agree that a majority of investors out there do not have the time to invest in an effective and functional trading strategy. If you plan to follow this strategy and hope to make serious money in the long term, you need to keep an eye on the market all day long, every single day. Timing the market is not an approach that you can use at irregular intervals and for a few minutes.
Even if you get lucky and make a considerable amount of money, it is not a strategy that will survive in the long term. This is evident as many investors who choose to follow this route often lose a lot of money in the long run.
Here are some other reasons why market timing appears to be a bad idea for most investors out there:
i. Opportunity Costs
A majority of investors usually make most of their profits over a few days, especially when the market performs exceptionally well. Missing these few, short days on the premise that you are out of the market may result in a significant loss of money.
ii. Trading or Transaction Costs
Buying and selling of securities costs a lot of money and these expenditures eat into whatever profits or gains you may earn. This could end up costing you a boatload of money in the long run.
iii. Taxes or Taxation Costs
It is a known fact that short-term gains attract high tax rates. Taxes also reduce your profits and – as with trading costs – lead to a considerable loss of money.
Many investors count market timing as a corporate form of gambling since it is based purely on chance. This is because most of them do not rely on overvalued or undervalued markets.
Market Timing: Does it pay?
Market timing is not an impossible endeavor as some investors have been able to use this strategy to accurately foresee market shifts consistently, thereby gaining a substantial advantage over their buy-and-hold counterparts.
According to the estimation put forward by Morningstar, between 2004 and 2014, some portfolios that were managed actively and moved in and out of the market returned 1.5% below passively managed portfolios. To gain an edge, therefore, active investors, i.e. those who make use of the market timing strategy, have to be accurate or precise at least 70% of the time. This is practically impossible over that period.
A Few Short Tips to Keep In Mind about Market Timing
i. Consider Long-Term Cycles – Recall that bull markets became virtually non-existent in the sixth year of the Ronald Reagan administration as well as the eighth years of both Bill Clinton and George Bush’s administrations.
However, the Obama/Trump bull market continues to thrive since 2009. These notable cycles and analogs indicate one thing; the significant difference between exceptional returns and misplaced opportunities.
Long-term market forces that are somewhat similar include:
• Currency trends
• The ebb and flow of interest rates
• Nominal economic cycle
ii. Make Your Purchases within Ranges that Establish New Trends – Markets have the tendency to trend lower or higher – up to 25% of the time – within all holding periods and may even proceed sideways and trade ranges during the remaining 75% of the time.
Taking a brief review of the monthly price pattern will help in determining how prospective investments will line up along the trend-range axis. Such price dynamics follow the age-old market wisdom that declares, “the bigger the move, the broader the base.”
iii. Keep an Eye on the Calendar – Financial markets – just like any other commodity markets – also experience annual cycles which tends to favor unique strategies at different times of the year.
For instance, tech stocks are known to perform remarkably well from January to the summer months, then trail off or decline until November or December. Small caps – i.e. companies with a comparatively small market capitalization or market value of its outstanding shares – show what is known as “relative strength” in the first three months of the year. It eventually fades away into the fourth quarter during which speculations on the new incoming year rekindles interest.
(Relative strength is the momentum investing procedure that evaluates the working effectiveness of an ETF (exchange-traded fund), a stock or mutual fund to that of the global market.)
Both of these cycles clearly adopt the “Sell in May and go away” strategy which is based on the past shortfall of stocks in six months that starts in May and lasts through October as against the November to April period.
Market timing may get a bad rap, but if carried out using technical analysis, it can result in profitable investments as well as other long-term positions. This involves finding the best times and prices to take disclosure to book profits.
Furthermore, these ageless concepts can be developed such that active investments will be adequately protected and red flags raised immediately when market conditions change extensively.
Our FX, bond, and stock market risk ratings have been created to indicate the potential risk of investments on an aggregated basis in percentage points. A low percentage reading suggests a positive and rather low-risk environment for the respective market.
Generally, a risk level equal to or above 60% should indicate a relatively high-risk and unfavorable market environment.
More information about our intuitive risk ratings and how they work at Market Risk Ratings - How it works.
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