Investing - A Pithy View Of Market Timing

Few days ago we wrote an article about market timing. It contained performance charts (for stocks and bonds) that compared the strategy of timing the market with a couple of other investing strategies.

There were some interesting comments on that article. We thank our readers for sharing their wisdom. While trying to respond to the comments we realized that it would be worthwhile to convert the response into a post. The guiding notion was the fact that our readers would benefit more from our response as a post.

Adventures In Money Making said...
Sorry, but i'll disagree with you.
If you read Ben Stein's excellent book "yes, you can time the market" he despells the myth that market timing doesn't work.
what is market timing? its buying something thats undervalued and selling it when its overvalued. (its not buying it on monday and selling it on the following thursday).
if you don't know how to analyze stocks, and you buy just because your bro-in-law said so, then yes, timing will not work for you.
other than that, its just a myth perpetuated by wall street.

Market TimingWe thank Adventures In Money Making for sharing his view with us. We have not yet read the above mentioned book. We hope to do so in near future. Having said that let us first delve into an understanding of market timing.

Definition(s): Market Timing

Market timing is the strategy of making buy or sell decisions of financial assets (often stocks) by attempting to predict future market price movements. The prediction may be based on an outlook of market or economic conditions resulting from technical or fundamental analysis.

1. The act of attempting to predict the future direction of the market, typically through the use of technical indicators or economic data.
2. The practice of switching among mutual fund asset classes in an attempt to profit from the changes in their market outlook.

Moving in and out of market in matter of minutes is also market timing, albeit an extreme form of market timing. Many active day traders do that.


Market TimingThe operative words in the above definitions are prediction and analysis. Now let us consider the following points.
  • Prediction by its very definition is not a guarantee. (For that matter no investment strategy is a guarantee. We wish we had a crystal ball!)
  • To predict meaningfully (for market timing) one must have the ability to do technical analysis.
  • In order to do any amount of technical analysis an investor needs:
    • access to lots of economic data
    • sophisticated tools and software
    • appropriate skills, training and knowledge
    • time, energy and effort

In our humble opinion, for an average investor it would be very challenging to fulfill all the above requirements. It is best left to the professionals and extremely savvy investors.

Of course for decades thousands of professional investors are doing just that - trying to time the market. Most active mutual fund managers are also playing the same game. Now we wonder:
  • Why is it that only a handful of mutual fund managers have beaten the market (for example, let us assume S&P 500 represents the market) year-after-year? Many of them failed miserably.
  • Why are likes of Warren Buffet and Peter Lynch such rare finds?
  • How many professional investors have been consistently successful over a long period by employing the investing strategy of market timing?
Our research indicates that there is very little evidence of success with market timing over the long run. Of course there have been reports in favor of market timing but they are few in number. Here is one such report (pdf) that discusses successful market timing strategies.

We understand that in very specific circumstances market timing can be effective with a high degree of probability. But those circumstances themselves are random phenomena!


Market TimingLast, why is it so difficult even for the professionals to time the market successfully and consistently in spite of having all the time, knowledge, training, cutting edge tools and privileged access to tons of economic data? We believe that the following issues may shed some light to this question.
  • The market behavior is extremely complex.
  • The number of parameters affecting the market is humongous. Are all the parameters known exhaustively?
  • Market behavior involves an important factor known as human psychology. To this date human beings do not or cannot understand their nature clearly. If the understanding itself is fuzzy, then how can we model it mathematically to perfection?
  • There are unknown factors such as a natural or man made calamity, epidemic, war etc.
  • Human vices such as greed for making hefty bonuses and personal gains through unrighteous means. So many corporate frauds and accounting scandals have come to the fore of late. Who gets burned - the average investor for sure!

market timingAfter considerable research we have been lead to the belief that following a market timing strategy of investing is not an average investor's cup of tea even if we assume that it works with some degree of certainty. This is our humble understanding at this point of our financial journey. As a responsible investor each one of us ought to do research, contemplate, experiment and determine which strategy is most appropriate for us. We wish Good Luck to all on this fascinating journey of discovering our financial selves!

Image Source(s): iStockPhoto

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