Market timing
Market timing refers to act(s) of investing based on the condition of the market as opposed to personal characteristics.[a] For example, adjusting one's asset allocation toward greater fixed income holdings because the bond market has lost value recently and there is an expectation of a bond market recovery would be an act of market timing. On the other hand, adjusting one's asset allocation toward greater fixed income holdings because it is in one's asset allocation plan to do so (e.g., as one ages), is not an example of market timing.
Market timing is typically applied to stocks:[1]
- "It has always been an investor's dream to be able to time the market and earn excess returns. The technique of market timing is simple: Remain invested in the stock market when expected returns are high and switch to cash investments when the market is expected to underperform. The timing of the switch is indicated by signals based on sentiment or fundamental indicators."
The problem is finding a market timing rule that can work in the future, as opposed to the past. In William Sharpe's words, "the top or bottom of a cycle is only obvious after the fact (and sometimes long after the fact)".[2] The same author has calculated that to simply match the returns of a buy-and-hold strategy, a market timer must be right 70% to 80% of the time.
Jeffrey wrote:[3] "a market timing strategist has tremendous natural odds to overcome, and (...) these odds increase geometrically with the length of the time frame and the frequency of the timing interval".
Can it be done?
Evidence from mutual fund investors
One way to evaluate whether market timing and performance chasing work better or worse than a buy and hold strategy is to compare the average return of mutual funds with the money-weighted return of investors in the same funds. In other words, are investors improving their returns by chasing hot funds, moving to cash and back to stocks, etc.? Morningstar has calculated the following average US data over five 10 year periods ending in 2014, 2015, 2016, 2017, and 2018:[4]
Fund category Fund return Investor return Gap Equity 6.8% 6.3% 0.6% Fixed income 4.0% 3.4% 0.6% Asset allocation 5.3% 5.5% -0.2% Alternative -0.6% -2.1% 1.4%
The table shows that on average, over 10 year periods, US investors in equity and fixed income funds earned 0.6% less than the funds there were invested in. It seems that asset allocation funds (including balanced funds, target date funds, etc.) are helping US investors behave better, on average. All funds considered, the results were similar in Europe, with a 0.5% average gap between fund returns and investor returns.
Evidence from investment newsletters
In a study of 237 investment newsletters over the 1980-1992 period, Graham and Harvey (1996) showed that less than a quarter of market timing recommendations were correct.[5] In another study, 68% of market timers were correct less than half the time.[6]
Conclusion
Some studies show that certain market timing rules could theoretically have worked in the past (in back tests), assuming zero costs, no taxes, and perfect execution (see [7] for a review of the timing literature and a statistical evaluation of thousands of trading rules). The problems in applying those systems in real life are:
- Will the same system continue to work in the future, or did it work in back tests by random chance?
- Will the investor have the required discipline to follow the system mechanically, with "robotic, unemotional precision", over many years?[8]
- Will any outperformance survive taxes and costs?
Neuhierl and Schlusche (1991) wrote that "when considered in isolation, the best-performing rule beats a buy-and-hold strategy over the full sample period from 1981 to 2007 and over both subperiods. Applying (statistical) tests to adjust for the effects of data snooping, we do not find superior performance of the best market-timing rule over the benchmark in any period".[7] Yet the dream lives on. A possible reason why market timing persists is overconfidence.[6]
Notes
- ^ Investopedia Market Timing: What It Is and How It Can Backfire says:
Key Takeaways
- 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.
- If investors can predict when the market will go up and down, they can make trades to turn that market move into a profit.
- Market timing is the opposite of a buy-and-hold strategy, where investors buy securities and hold them for a long period, regardless of market volatility.
- While feasible for traders, portfolio managers, and other financial professionals, market timing can be difficult for the average individual investor.
- For the average investor who does not have the time or desire to watch the market daily—or in some cases hourly—there are good reasons to avoid market timing and focus on investing for the long run.
See also
- Market timing, Bogleheads wiki
References
- ^ Neuhierl A, Schlusche B (2011) Data snooping and market-timing rule performance, Journal of Financial Econometrics 9:550–587, available at SSRN, viewed June 16, 2020.
- ^ Sharpe W (1975) Likely gains from market timing. Financial Analysts Journal 31:60-69, viewed June 16, 2020.
- ^ Jeffrey RH (1984) The folly of stock market timing. Harvard Business Review, July-August 1984
- ^ Kinnel R et al. (2019) Mind the Gap 2019 -- A Report on Investor Returns Around the Globe. Morningstar, viewed June 12, 2020.
- ^ Graham JR, Harvey CR (1996) Market timing ability and volatility implied in investment newsletters' asset allocation recommendations. Journal of Financial Economics 42:397-421, PDF available on ResearchGate or SSRN, viewed March 11, 2025.
- ^ a b Antoons W (2016) Market timing: opportunities and risks. Brandes Institute Research Paper 2016-06, 19 p., available on SSRN, viewed March 11, 2025.
- ^ a b Neuhierl A, Schlusche B (1991) Data snooping and market-timing rule performance, Journal of Financial Econometrics 9:550–587, preprint available from Penn State University, viewed March 11, 2025.
- ^ Canadian Couch Potato blog, Why I Have No Faith in Market Timing, May 17, 2012, viewed March 11, 2025.