What is Market Timing and Does it Work?

If you invest in the stock market, you might be pretty frustrated by the huge swings you’ve been experiencing on a daily basis.

That’s especially true if you’re trying to amass enough money to retire one day.  In an effort to mute those terrifying swings you might be interested in alternatives.

One of those alternatives is timing your investments.

But just what is market timing?


Market timing is the process by which you either buy or sell certain investments based on objective, observable data.

Let’s break this down before we talk about how effective it is.

First, it’s a process.  And it’s a process you can document.

That means you don’t buy or sell based on your feelings or a hot tip you get from Uncle Joe.  Oh, of course you can do that, but if you do, it’s not market timing.  It’s speculating and guessing.

The next segment of the definition is ‘certain investments’.

You can have a process that guides not only when to buy but what to buy as well.

It might be certain stocks, mutual funds or ETFs.  It might be very broad based funds like the S&P 500 or it might be something very specific like Apple stock.

Each market timing strategy has its own investments.

‘Objective, observable data’ is the next phrase we should understand.

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As I said towards the start of the post, ‘market timing strategies‘ involve relying on information.

You don’t buy and sell based on what you ate for breakfast or heard on the radio that day.

If you have a system, it must rely on what is actually going on in the market in terms of price, volume and a variety of other indicators.

Now that we’ve discussed what market timing is, let’s consider if it works or not.

Market Timing

Market timing can work under the right circumstances.

Unfortunately, there is no answer.

In fact, when someone says, “market timing doesn’t work,” it’s like saying “cars get into accidents”.  Yes, cars do get into accidents.  But not all cars get in accidents.  And not all cars get into bad accidents.  And even if your car gets into an accident, does that mean it’s too dangerous to drive one?

Market timing can work.

But it doesn’t work perfectly.  It certainly doesn’t guarantee success in any particular time period.  And a large component of success is a function of what system you use and what kind of investor you are.

Often, investors investigate market timing strategies that work, implement one, and find it doesn’t work for them.

Why?

Because the investor themselves fail to apply the system consistently.

This explains why really smart people still lose money.  They over-ride a buy or sell decision of the system because they feel something.

A good market timing strategy will work when executed over many, many years.  It won’t work day after day, month after month, year after year.  In fact, some of the best market timing strategies have long stretches of underperformance.

That just goes with the territory.

So, to answer the question, does market timing work, you have to be very clear how you define “work.”

In my opinion, an investment strategy works if it helps you achieve your long-term goals with less risk and cost over the long-term.

Let me share an example with you.

Let’s say one particular market timing strategy yielded the same long-term results as buy and hold.  The only difference was that in any particular year, when the market was very bad, the market timing strategy cut out a great deal of those losses.  And in any particular good year, this same market timing strategy did OK but not as well as the buy and hold strategy.

Would you say the market timing strategy failed?

I wouldn’t.

If the investor was someone who wanted to grow her money but not take on too much risk, this strategy did fantastically well over the long run.  Of course, it’s no guarantee of future results, but if you can invest and shield yourself from the emotional upheaval of horrifying losses, that’s a pretty good thing.

Wouldn’t you agree?

Do you try to time the market?  What is your market timing strategy?  How has it worked out?

The following is guest post from Neal Frankle.  He’s a Certified Financial Planner in Los Angeles California.  He is also the owner of Wealth Pilgrim, a top notch personal finance blog.

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Published or updated July 14, 2013.

Comments

  1. Thank you Neal. Unfortunately, market timing has become the big bad wolf in some parts of the PF community. I recently read (and wrote about) an article that compared it to whiskey. It may not be for everyone, but it doesn’t have to be taboo either. Thanks for shedding a little light on the topic! ;)

  2. If you are using valuation to time the market, that is smart! If you are listening to the culture or talking heads you are probably headed for disaster. I use a tactical asset allocation strategy which invests more aggressively when valuations are bargains and more conservatively when valuations are high. Here is how a tactical asset allcoation works for anyone interested:
    http://arborinvestmentplanner.com/tactical-asset-allocation-strategy.php

  3. @Balance – great analogy. Mind if I use it???

    @Ken. I am w/you. Too many investors lump all non-buy and holder’s into one camp. That’s unfortunate. I like your valuation approach. Question — do you take a macro view of the market too or do you just evaluate the stock?

  4. Great detailed article on a difficult subject. I think that market timing is essential but it does take time and effort to be able to closely monitor and respond to market variances

  5. Neal
    I use valuation for both the individual stocks and a macro view for my over all asset allocation. My favorite valuation metric for individual stocks is Return on Enterprise Value (ROEV). Then I adjust my overall asset allocation (if needed) with inverse ETFs.
    http://blog.arborinvestmentplanner.com/2011/05/best-stock-valuation-calculation-to-value-company-shares-is-roev

  6. Thanks Ken. I will certainly check out your post.

  7. In stock market, timing is always important. The right timing when to buy and/or sell stocks is the key to earn more from your investment. Thanks for the post!

  8. Travel Broker says:

    The act of attempting to predict the future direction of the market, typically through the use of technical indicators or economic data. Long-term timing is a different matter. The historical stock-return data indicates that long-term timing works.

  9. @Travel Broker I might agree but I’d need to know how you define “long term” and “works”.

    What is investment success? If you are right 52% of the time and wrong 48% is that a success? What if your wins were much greater than your losses?

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