Daily Gains Letter

Does Market Timing Actually Work?

By for Daily Gains Letter | Apr 5, 2013

















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Market timing has become one of the most discussed topics among investors these days. With a significant amount of fluctuation in the key stock indices and their attempts to break above their highs, investors are asking if we are standing near a top in key stock indices or if we are going much higher.

At the very core, market timing is essentially trying to predict the top or bottom of a market to act accordingly—those investors who follow this strategy tend to believe in the buy-low/sell-high way of investing.

With this said, investors must keep a focus on the long term, because market timing can go wrong. To look at how wrong it can be at times, we don’t really have to go far. Just look at what happened in 2008 and 2009—a classic example of when market timers may have faced some severe losses.

Consider the chart of the S&P 500 below.

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Chart courtesy of www.StockCharts.com

In the summer of 2008, the S&P 500 started to decline, but the sell-off didn’t really start till October. By mid-October, the S&P 500 was around the 750-point level. For those who remember, it wasn’t a great time to say the least.

If market timers thought that the S&P 500 had bottomed, then they were in for a long misery, because the bottom didn’t really occur until March of 2009—when the S&P 500 declined to below the 670-point level.

With market timing, what holds true is that rewards can be huge. Just look back at the chart of the S&P 500 above; the index traded below 670, and it is now trading around 1,550—meaning it’s more than doubled since. But, investors would have had to be right about the bottom to see their portfolio grow!

As great as it may sound, the biggest concern with market timing is that it is difficult to be consistent. It is much more difficult to be right on every single top and bottom. There were some advisors who picked the bottom correctly in 2009, but they were the minority. And it was hard to digest the fact that markets won’t go any lower when everything appeared to be falling apart.

If investors do try to time the market, then at the very least, they must consider proper trade management techniques. The reason behind this is very simple—they can be very wrong time and time again. So, they must protect their savings from further deterioration in the markets.

One more thing to note: when an investor is trying to time the market, they might be distracted by their emotional impulses in believing that this is the lowest or the highest a certain stock or index can go. The problem lies in what makes a stock “too high” or “the lowest.”

Investors should keep their focus on the bigger picture—over a long period of time, they can reap the rewards. Chasing short-term gains and predicting top and bottom does nothing but make an investor’s portfolio vulnerable to more losses. To “get in at the right time” or “sell at the right time” can make a huge impact on a portfolio if an investor is wrong and can even bring its value to zero.

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