Market Timing (MT) is a strategy investors commonly use to beat the stock market. Even though some investors benefit greatly, most economists still doubt this money-making method and consider it risky and ineffective.
Market timing is purchasing or selling financial assets by attempting to forecast future market price fluctuations.
This strategy is often employed in the stock market. Investors determine when to buy or sell shares based on their prediction of either the increase or decrease of the price per share.
In addition to the stock market, the timing can also guide investments in gold, bonds, or real estate.
For example, if interest rates rise, the market timer may sell some of his stocks and buy more bonds. They maximize their profit by moving their investment money in and out of the market based on their prediction of future market fluctuation.
How to time the market?
Predicting the market is the key to this process. Market timers forecast the market. And they attempt to sell at the 'top' of the market and buy at the 'bottom.'
This strategy is primarily attributed to the investors' predictions based on their previous investing experiences and studies of historical price charts, mathematical and quantitative data, etc.
Institutional investors frequently employ proprietary market-timing algorithms created in-house, which may be a trade secret. Some algorithms have been published in peer-reviewed papers that seek to forecast the future superiority of stocks over bonds.
If the future market follows the investor's prediction, he will benefit from this strategy. However, if the future demand exceeds his expectation, he will lose money.
The prediction-based method makes this an active investing strategy in which the investor watches the daily market performance and keeps an eye on any subtle changes.
But also, some psychological effects can influence the investors' decisions. For example, one piece of bad news may result in anxious sentiments for the market timers, and this causes many investors to go out of the market immediately.
It needs to be mentioned that this strategy is not illegal. On the contrary, some opportunists earn tons of money by doing this. The money they earn pays back the relentless effort they put into predicting.
In summary, following the banner of "buy high and sell low," stock investors who regard themselves as market timers forecast the market based on their scientific methods and, most importantly, their confidence to beat the market.
Understanding the Pros and Cons of Market Timing
It is a controversial strategy for investment. Its proponents and opponents have debated this method's feasibility for decades.
Pros
The proponents believe that MT particularly fits the ideology of short-term investors. So it is because the investors can quickly exit from the market and prevent huge losses if they successfully predict the downturn.
Likewise, if they can predict the sudden uprise of a particular industry or stock market, they benefit from this market timing strategy.
Hence, this strategy encourages investors to take risks, given that high chances are generally equal to high returns.
Cons
1. It is hard to predict the market
The main criticism is that this strategy is considered a form of gambling based on pure chance, and it is impossible to find the perfect time in the market and make a hundred percent 'correct' decisions.
Given that the economy is a complex system that contains many factors, even in a period of significant optimism or pessimism, it is still challenging to predetermine the future prices of the market. Economic bubbles can last for years before they collapse.
It has been demonstrated that few people correctly predicted the timing and causes of the Great Recession during 2007–2009. So, It is tough to expect anything in the ever-changing world.
(Tips: In response to the unpredictability, the proponents argue that MT is another name for trading. All Investors trade with one another based on their prediction of the future market price. So, people are still predicting even though the market may be unpredictable.)
2. High Standards for the investors
Additionally, the strategy demands too much time and energy from the investors. They have to watch the market news more frequently than those long-term and passive investors.
Plus, the investors need to have enough background knowledge of the market and the ability to read historical charts. This needs to be clarified for many new handers from this method, which requires too much experience and expertise.
3. Unnecessary fees are incurred
Moreover, market timers tend to transact more routinely than those long-term investors. Hence, the transaction fee and possible commission costs are other significant issues for investors who exit the market quickly.
Finally, if you perform successfully on several investments within one year, your profit is taxed at the short-term capital gains rate, which is higher than the long-term capital gains.
Hence, the net profit for market timers is usually low if you consistently invest your money and look at the market regularly.
There are more cons than pros to this strategy. For new investors, there should be some alternative methods of investing.
What are some alternatives to this strategy?
As previously said, this strategy has three significant disadvantages -
- unpredictability,
- expertise requirement, and
- unnecessary fee increment;
here are some alternative investing methods to avoid these inconveniences and difficulties.
1. Buy-and-hold strategy
Buy-and-hold is an investment strategy in which investors buy stocks and hold them long-term, regardless of short-term fluctuations. It is also a passive investing scheme because you take a few initiatives.
For example, you buy shares from a company and hold them for five years. With a buy-and-hold strategy, the dramatic increase in the price per share next week and the unexpected price fall have no effects on you. Instead, you hold the stock for five years.
Buy-and-hold is the opposite of a market timing strategy because you must pick the right moment to get in the market and the time to be out. So instead of making predictions, You are always in the market and waiting for the result.
You reduce the risks of losing money with this strategy, save a lot of transaction fees, and benefit from the capital gains rate tax for long-term investment. Also, you can spend less energy watching the market, which makes you exhausted.
To buy and to hold, however, does not mean that you put your investment aside once you dump your money into the market. Instead, regular checkups and annual reviews are necessary to keep you on track with your goals.
But on the other hand, the market timing scheme is more flexible than the buy-and-hold strategy. As a result, you may miss bear markets which bring you wealth in one night.
2. Dollar Cost Averaging Strategy
Both buy-and-hold and market timing strategies give investors a lump of money to invest at once. But a dollar-cost averaging process is a good resolution for new starters who need more capital and want to minimize the risks.
Dollar-cost averaging removes emotion from investing by requiring you to buy the same small amount of an asset regularly. This means you buy fewer shares when the market is high and more when the market is low.
For example, instead of buying a mutual fund of 1200$ at one time, you split it into 12 months and invest 100$ in this fund per month. As a result, you may have more shares in the first month than in the second. But this change has little effect on your total wealth.
This strategy ensures you invest even when the market is down. For some people, maintaining investments during market dips can be intimidating. However, if you stop investing or withdraw your existing assets in down markets, you risk missing out on future growth.
Should one focus on market timing or their time in the market?
In the previous paragraphs, market timing is a failure for unsophisticated investors to build wealth. Conversely, the buy-and-hold and dollar-cost strategies are highly encouraged because the investors should focus on the 'time in the market.
"Time in the market" refers to a technique that does not rely on guessing when the market is at its lowest or maximum point, as market timing does.
Those "time in the market" investors are always in the market and waiting for long-term appreciation unless their original buying intentions change, so they have to exit the market.
There are better strategies than making short-term projections for those who choose to stay in the market. Time and patience are more valuable in the market than a quick transaction.
For example, if a person holds a stock for twenty years, the benefits of compounding and investment growth might be enormous. By allowing their assets to expand over time, patient investors earn more.
To put it in simple words, you should not find a perfect time to get in the market and another perfect time to get out. Instead, you'd better always be in the market, i.e., actively investing and waiting for more stable results.
According to one research, the market timer must be correct 74% of the time to perform better than its counterpart, i.e., passive investors, of the same risk. So, do not think you are clairvoyant and provident; focus on the market's time, not market timing.
Key Takeaways
- Market Timing is the strategy of moving money in and out of the market. The timer tries to predict the best time for them to conduct the transactions.
- It has been used mainly in the stock market when investors try to buy the shares at the lowest price and sell them at the highest, usually within a short period.
- The pros of this strategy are that it is very flexible. A good and wise prediction can help you avoid losing money. But chances are low.
- The cons to this strategy are too many. To name a few: the unpredictability of the market, high standards for inexperienced investors, and the unnecessary fees that may incur.
- The buy-and-hold strategy and dollar-cost averaging strategy are perfect substitutes for market timing. They both encourage you to have long-term and stable investments that do not require you to eying on the market all day long.
- Focus on the time in the market, not timing the market. Always staying in the market instead of waiting for a perfect time. The only ideal time to invest is 'now.'
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