Market Timing What It Is and How It Can Backfire

Market timing is the act of moving investment money in or out of a financial market—or switching funds between asset classes—based on predictive methods. Investors can make trades to turn market movements into a profit if they can predict when the market will go up or down. Market timing is a key component of actively managed investment strategies and a basic strategy for traders. Predictive methods for market timing decisions include fundamental, technical, quantitative, or economic data.

However, it is debated whether successful market timing is possible. While some investors strongly believe in market timing, many professionals argue that timing the market for any substantial length of time is difficult. Despite this, it is not impossible to time the market. Short-term trading strategies have been successful for professional day traders, portfolio managers, and full-time investors who use chart analysis, economic forecasts, and even gut feelings to determine the best times to buy and sell securities. However, few investors have been able to predict market shifts consistently enough to gain a significant advantage over buy-and-hold investors.

Market timing is often viewed as the opposite of a long-term buy-and-hold investment strategy. However, even a buy-and-hold approach can involve some level of market timing due to investors’ shifting needs or attitudes. The key difference lies in whether market timing is an intentional part of the investor’s strategy.

For the average investor who lacks the time or desire to monitor the market daily, there are good reasons to avoid market timing and focus on long-term investing. Active investors argue that long-term investors miss out on gains by not taking advantage of market volatility through timed exits. However, it is challenging to accurately gauge future market direction, and investors who try to time entrances and exits often underperform those who remain invested.

Market timing has advantages such as the potential for bigger profits, curtailed losses, avoidance of volatility, and suitability for short-term investment horizons. However, it also has disadvantages such as the need for daily market attention, more frequent transaction costs and commissions, tax-disadvantaged short-term capital gains, and the difficulty of timing entrances and exits.

Critics of market timing point out that accurately timing the market is challenging. A seminal study by William Sharpe found that a market timer must be correct 74% of the time annually to perform as well as a passive index fund. Even professionals struggle with market timing, as evidenced by target-date funds that attempted market timing underperforming other funds.

Actively managed funds generally fail to beat their benchmarks, with only 23% of all active funds surpassing the average of their passive rivals over a 10-year period. Market timing also requires continuous monitoring of securities, funds, and asset classes, resulting in tedious, time-consuming, and draining efforts. Each market entry or exit incurs transaction costs and commission expenses. Additionally, market timing can lead to higher tax rates, and determining the optimal entry and exit points is a complex task.

In conclusion, market timing is a strategy that involves predicting and capitalizing on market movements. While some investors have achieved success with timing the market, it is difficult to consistently outperform buy-and-hold strategies. For the average investor, market timing is often less effective and generates smaller returns compared to long-term and passive strategies. It requires constant attention to markets, incurs additional costs, and presents tax implications. Therefore, many professionals recommend focusing on time in the market rather than timing the market.