In this article you will find out more about:
What Is Market Timing
Market timing refers to the strategy of attempting to predict future market movements in order to buy or sell securities at advantageous prices. The goal of market timing is to buy low and sell high, thereby maximising returns on investments. This strategy involves continuously monitoring and adjusting a portfolio based on predictions about market trends, economic indicators, and other factors that may impact the value of securities. Market timing is considered a form of active investment management and is often contrasted with a passive investment strategy, such as buy-and-hold, in which an investor simply holds a portfolio of securities over a long period of time without making frequent adjustments.
Different Market Timing Strategies
There are several market timing strategies that investors use to try to predict market movements:
Trend following: Trend following strategy involves identifying a current market trend and making trades based on that trend. For example, an investor may buy stocks if they are trending upwards and sell if they are trending downwards.
Momentum investing: Momentum strategy involves buying securities that have shown strong recent performance and selling those that have underperformed. The theory is that momentum will continue and the securities that have performed well will continue to do so.
Cyclical investing: This strategy involves making investments based on the stages of the business cycle. For example, an investor may buy stocks when the economy is in a growth phase and sell when it is in a contraction phase.
Technical analysis: Market timing strategy which involves using charts and other technical indicators to identify trends and make investment decisions.
Fundamental analysis: Market timing strategy which involves using economic, financial, and other qualitative and quantitative data to make investment decisions.
Timing the market is generally considered to be a difficult and uncertain endeavor, and many financial experts advise against relying solely on market timing strategies for investment decisions. One of the main challenge for timing the market is the influence of investor's behaviour on buy and sell decisions.
What Drives Investors' Behaviour
Every investor is driven by emotions, for example fear and greed. More cautious persons tend to hesitate to buy as they think assets like shares are "too expensive" and hope for a better entry point at lower prices. Greedy ones try to jump on the bandwagon as they fear to miss a strong upward move of the markets if not being invested. But who knows when the trend is changing and the low or high has been reached? Nobody - not even AI-driven supercomputers. In his publication "The mathematics of market timing" from July 2018, Guy Metcalfe summarised that "simple math says market timing is more likely to lose than to win — even before accounting for costs."
Performance of Different Market Timing Strategies
Let's assume there are five different persons who are convinced of different investing styles and want to compete in the race who will accumulate most wealth over 20 years time. All five receive a bonus payment of $2,000 at the beginning of each year starting 2001 over a 20 years horizon which they invest into a S&P 5oo index tracker or US treasuries as follows:
Perfect Market Timer - this person always invested at the lowest price during a year - every year during the 20 years period. In 2021, for example, this was on the September 21. In 2002, the lowest entry point was on October 9 when the Perfect Market Timer again invested his $2,000 bonus payment from the previous year.
Saving Planner - this person split his $2,000 bonus into twelve equal payments and invested at the beginning of each month - for a period of 20 years.
Immediate Executor - as soon as the $2,000 bonus was received, the money was invested into the S&P 500 index tracker on the first trading day of the year.
Worst Market Timer - similar to the Perfect Market Timer but with extremely bad luck picking always the day when the S&P 500 hit its peak during a year (e.g., in 2001 that was on January 30). Watch also the movie with Bob, the world's worst market timer, who only invested when the market peaked.
Treasury Holder - always cautious, avoiding any potential risks and waiting for a better entering point as shares always seem to be too expensive. Therefore, shares are not in this person's portfolio for the entire 20 years period. Instead, the bonus payments are invested into US treasury bills.
Guess who accumulated the highest wealth until the end of the 20 years investing period in 2020? Of course, the Perfect Market Timer with an accumulated wealth of $151k. But Saving Planner and the Immediate Executor follow with a difference of only around $20,000 - even the Worst Market Timer accumulated an astonishing amount of $121k. And the Treasury Holder lost the race to become rich: only $44k are shown on his portfolio statement in 2020.
In the following short movie it is nicely shown how Bob, the world's worst market timer, has accumulated his significant wealth.
How NOT to Find the Right Moment to Invest - Examples for Bad Market Timing
In order to improve their market timing, investors often look into the past and compare the current situation with previous ones in order to anticipate how markets will develop. Did the market go up when interests were lowered by the national banks? How did bonds react? But this looking at past performance approach doesn't help when it comes to better returns due to market timing.
With regards to mutual funds, private investors tend to make their investment decision based on past performance and literally miss the previous periods with strong positive returns and sell frustrated by market underperformance, generating losses in their portfolios. SPIVA Scorecards from S&P measure the systematic underperformance of actively managed investment funds compared to passive index investing strategies.
A good example for failing to time the markets were algorithm driven robo-advisors (e.g., using value at risk based models). During market turmoil like in 2020, many AI-driven portfolio managers were causing first trouble to their clients by realising profits or losses with tax implications and then invested back into the market when the recovery rally was already ongoing, missing out some good returns. Market timing did not contribute to a better performance at all.
Why Market Timing Might Not Lead to Outperformance
What smart people found out was, that horrible days with markets declining drastically were very close to days with best performance in a year. For those who sold when markets started to decline, this comes with the challenge to miss the strongest uptrend nearby. Besides, selling and buying comes along with some trading costs which lower your return at the end. Overall, market timing often leads to transaction and opportunity costs, lowering the overall return of a portfolio. Besides, taking profit when selling will trigger also capital gains taxes.
What Is the Best Approach to Time the Market - Conclusion
Investors following a disciplined buy-and-hold approach with a globally diversified portfolio composed of preferably low-cost index funds like ETFs, do not face such challenges, simply sit out any market turmoil and benefit most from the compound effect. Against any hesitation due to negative emotions linked to heavy temporary losses on paper, it would be even clever to look for additional cash to invest for taking advantage of the cost average effect.
See also what Vanguard's founder Jack Bogle said in his last CNBC interview about market timing:
So, what to do during next market turmoil? Trying to time the markets? No, simply almost nothing, except from enjoying buying at lower prices whenever your cashflow does allow you... market crashes offer excellent conditions for successfully rebalancing your investment portfolio. As further explained in the blog article, there are several scientifically proven benefits coming from regularly rebalancing your portfolio.
Disclaimer: The scenarios or investment products presented above should not be construed as investment advice. All investments involve some level of risk, and past performance is never a guarantee of future returns. As always, do your own research in order to validate and better understand the underlying risks.
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