What is market timing?
And how to ‘time the market’
Timing investment markets is everybody’s dream. Self-proclaimed “financial gurus” may lead you to believe they have market timing mastered, and that by following their steps you’ll be on a certain path to riches. In fact, if these self-proclaimed gurus knew how to consistently time the market the last thing they’d do is tell everyone else about it – they’d be far too occupied cruising the Mediterranean on their superyacht! But before discussing this in more detail, let’s define exactly what market timing is.
What is market timing?
Market timing, or ‘timing the market’ is an investment strategy where investors buy and sell investments based on expected fluctuations in investment prices. Price fluctuations are totally normal in the investing world as buyers and sellers of investments find agreement on the value of each investment many times a day, minute, and even second. For example, the NZ Stock Exchange – which reflects a tiny fraction of global investment markets – averages over $120 million in trading on most days.
If investors can correctly determine when the market will go up and down, they can make the corresponding investments to turn these natural market movements into profit. Over longer time spans, investment markets tend to move in cycles, which theoretically makes market timing a lot easier.
Buy low and sell high
In an ideal world, we’d all be able to make the most of these cycles by exiting our investments just before a market downturn, wait for the prices to hit rock bottom, then swiftly re-invest and make the most of the predictable bounce-back in value. In other words, for investors to have a shot at successfully timing the market, you must make the call to buy or sell an investment correctly not just once, but twice.
This is reflected in the old saying “buy low and sell high”.
Timing in practice
While this is all great in theory, in practice it is essentially impossible to do on a consistent basis. Some investors hit it right every once in a while but earning a profit from timing the market repeatedly is a fantasy for most.
Nobody knows with certainty what the future returns of any asset class will be (asset classes are different types of investment, such as property, shares, cash, and commodities including gold etc). Without that knowledge, there is no way to execute a perfect market timing strategy. The lure of trying to time the market may even tempt long-term investors, but outguessing markets isn’t nearly as straightforward as it sounds.
Headlines can deceive
One reason it’s tough to time markets is it’s often based on a snippet of information, such as an article from this morning’s newspaper, or something in a social media newsfeed, or perhaps a segment from the television business news. It’s nearly certain that this ‘new’ information is already reflected in prices by the time any investor can react to it.
Research shows the odds are strongly against it
First and foremost, investment markets are fiercely competitive and proficient at processing massive amounts of information.
No academic paper (or rigorous examination of ‘guru’ records) we’re aware of supports long-term market timing success. Study after study has shown that even professional investors struggle to time markets accurately, let alone part-time amateurs. Many studies go one step further and suggest that “…market timing is more likely to lose than to win – even before accounting for costs” such as the price for making an investment trade (brokerage) and time spent researching what to do. Yet another study states that “The data shows that when investors react, they generally make the wrong decision.”
Backing this up even further, a specialised company called Dalbar Inc has run data-based studies over the last 25 years solely dedicated to studying investor behaviour. Year after year their research shows that the average investor earns below-average returns – only 4.1 percent per year versus the share (stock) markets average return of 9.85 percent per year. Dalbar identify numerous reasons for this, but it basically comes down to incorrectly timing the markets.
The research is clear – market timing is essentially impossible. In fact, if you’re trying to do it, you’re probably going to do yourself more harm than good.
The good news is that investors don’t need to be able to “buy low and sell high” to have a good investment experience. Over time, investment markets have rewarded investors who have taken a long-term approach and remained disciplined in the face of short-term noise. Simply put, you can win by following the research-backed approach of “buy and hold”.