Market Timing

Title: What is Market Timing?

The notion of stock market timing is easily encapsulated by Will Rogers one-liner about investing - The general idea is to buy low and sell high. A stock market timing strategy is exactly that, an effort to capture most of stock price up turns and avoid most of down turns.

Even a cursory look at the much watched index averages such as the Dow Jones or the S&P 500 show the advantage of a market timing strategy. The index graphs look a lot like a mountain range with lots of peaks and valleys. It doesn't take a neurosurgeon level intellect to see that if you can catch the upswings and miss the down swings your investments would grow very nicely indeed.

A buy low sell high strategy isn't something most investors can do successfully without a plan to follow. History shows that when investors rely on emotions to making decisions about when to buy and when to sell they will be wrong most of the time. That's because when stock prices are falling fear sets in and they will not buy at anywhere near the best prices, and when prices are rising they get euphoric and think stock prices will rise endlessly and they miss the best selling point. In fact, without some sort of unemotional guide, what happens is people feel hopeful about investing is stocks only after the markets has been rising for some time, and decide to sell their holdings only after the market has taken a significant dive. This is pretty much exactly the opposite of what makes economic sense.

Does Stock Market Timing Work?

A lot of people would say no to that question, including many brokers, financial advisors, and financial writers. Several of their arguments go like this:

"In any ten year period stocks are always higher at the end than the beginning of the period." It turns out this statement was true between 1982 and the year 2000, but it isn't true all the time. After the 1932 market crash low it took seventeen years for the market to recover, in the late 1960s and 1970s the market didn't recover for sixteen years, and in the aftermath of the dotcom bubble high tech stock prices are still below the pre dot.com bubble highs.

"If you miss the best ten days of a bull market your returns will only be about average." Well of course they would, but there's no reason to believe a market timing approach would miss those ten days. I was talking with a stock broker friend of mine about this notion recently and his take on it was that if one had a choice between missing the ten best days or the ten worst days in a market cycle, choose to miss the ten worst days.

"You can't predict the market because price moves are random and at any moment on any day it can go up or down." This statement is true. No one can accuratly predict hourly or even daily stock price movements. However, we can accurately identify trends in stock prices by comparing the current stock price to how the stock has performed in recent months.

Stock market timing can work very well, it is easy to do and it can work for you too.

A Comparison Between Market Timing and Buy and Hold Investment Stategies:

Let's take a look at the time frame between January 1, 2000 and December 31, 2008 a nine year span. We will use Standard and Poor's 500 (S&P 500) Index price data and see how market timing compares to a buy and hold strategy (no market timing at all) to find out which approach would have yield the highest return on a hypothetical $10,000 invested by you in an S&P 500 indexed fund, which means the fund price moves will exactly match the Index. The following is a year by year graph showing the percentage of gains or losses for a buy and hold strategy and Price Wave Analysis (a successful market timing tool).

Nine Year Comparison Chart

The first thing you notice on the chart is that all the blue bars (Price Wave Analysis) are above the zero graph line meaning that your investment made money for you every single year. There were no losses, and only one year when the gain was less than 20%.

The second condition you notice is that with a buy and hold approach, your investment would have lost money during four of the nine years. In the actual market, you would have seen your initial $10,000 investment shrink to about half its value during the first three years; then grow again to about one hundred dollars above your initial investment; and then melt away again to about half value. So for nine years of effort using a buy and hold investment strategy you would have no gain in your investment.

Using a stock market timing investment strategy, the same amount invested in the same mutual fund over the same time period would have grown to over ten times the initial investment. A $10,000 investment would have grown to just over $100,000.

Stock market timing works.

Arley, Investment Timing Software

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