Time and again, there has been a debate whether market timing works. Market timing is termed as predicting the future direction of the stock market by using technical charts and economic data.
There is one camp that believes that investors can move in and out of the stock market and by doing so, maximize their returns. They do this by using moving averages and support and resistance lines on the charts, amongst others. While this might work sometimes, at other times, these investors might miss the sudden gains that the stock market makes out of nowhere. This was the case in March 2009 where the stock market suddenly sprang off its lows and never looked back.
The other camp believes that market timing is futile predicting the direction of the stock market. There are numerous studies showing that being out of the market during only a few of the best days or months can ruin a portfolio’s long-term returns. Here are some of them:
- Had you put $1,000 in the S&P 500 at the end of 1981, your stake would have grown to $25,584 (including reinvested dividends) by the end of 1998. But if you had missed the 30 best days (defined as the days with the highest percentage gain) of those 4,400 trading days, you would have ended up with $4,549, 82% less. (Source: Dow 100,000: Fact or Fiction.)
- Consider three people who each invested $1,000 per year in the S&P 500 Index from 1965 to 1995. Investor A bought on the first day of each year, Investor B — the world’s best market timer — bought at the lowest price each year, and unlucky Investor C bought at the market’s peak each year. Here are the results:
- Investor A (invests on first day of the year): 11.0%
- Investor B (invests at market nadir each year): 11.7%
- Investor C (invests at market peak each year): 10.6%
- As you can see, the differences among the compound annual returns earned by each investor are small. (Source: Peter Lynch, Fidelity Investments brochure, “Key Things Every Investor Should Know.”)
Some of the astute minds of the investing world like Warren Buffett and Peter Lynch are certainly against market timing. Here are some quotes by them:
Warren Buffett –
- “The only value of stock forecasters is to make fortune-tellers look good. Even now, Charlie and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.”
- “We continue to make more money when snoring than when active.”
Peter Lynch –
- “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
- “I can’t recall ever once having seen the name of a market timer on Forbes‘ annual list of the richest people in the world. If it were truly possible to predict corrections, you’d think somebody would have made billions by doing it.”
- “I don’t believe in predicting markets. I believe in buying great companies — especially companies that are undervalued and/or underappreciated…. Pick the right stocks and the market will take care of itself.”
- The evidence, based on more than 160,000 daily returns from 15 international equity markets, is clear: Outliers have a massive impact on long-term performance. On average across all 15 markets, missing the best 10 days resulted in portfolios 50.8% less valuable than a passive investment; and avoiding the worst 10 days resulted in portfolios 150.4% more valuable than a passive investment. Given that 10 days represent, in the average market, less than 0.1% of the days considered, the odds against successful market timing are staggering. Hence, of the countless strategies that academics and practitioners have devised to generate alpha, market timing does not seem to be the one most likely to succeed.
- A very small number of days account for the bulk of returns delivered by equity markets. Investors do not obtain their long-term returns smoothly and steadily over time but largely as a result of booms and busts. Being invested on the good days and not invested on the bad days is key to long-term performance. But the odds of successfully predicting the days to be in and out of the markets are, unfortunately, close to negligible.
I feel market timing is not worth an investor’s effort as seen from the examples, researches and quotes above. I, too, have been guilty of market timing recently and I can strongly concur that market timing doesn’t work (at least for me)! I have learnt to just add on to my positions whenever there’s a significant dip in price. However, if my stock doesn’t move much, I will gladly hold on to my stock amid a financial meltdown and cash in on the dividends!