Newbie Investing: What Is Market Timing?
The investment world seems complex . Everything that surrounds financial markets tends to appear wrapped in a halo of complex graphics, technicalities, anglicisms and a myriad of variables that generate distrust and fear in most small savers. This is what happens with the concept of market timing.
However, the reality is that everyone should invest their money, and that doing so is much easier and easier than it seems . But for people to trust, lose fear and invest safely, more financial education is needed.
At Finance nemo we decided to do our bit for a long time. Since then, we have not lost the opportunity to explain the meaning of some of the main financial terms: index funds, stock index,ETFs, value investing … And this time, as we have told you, it is the turn of market timing.
What is market timing?
Market timing is an investment strategy that consists of entering and exiting the market depending on how it evolves . If the market is down, we will exit to avoid losses; and if it is on the rise, we will enter to ride the profit wave.
In short, it is about finding the right time to invest or divest certain asset classes. If we focus on the shares of a certain company, the market timing would consist of buying those shares when their price is expected to rise, and selling them when the price is expected to fall.
Market timing, therefore, is part of the very essence of investing : buying low and selling high . Or isn’t that what we’ve always heard to do? But the question we should ask ourselves is: is this investment strategy really effective?
To tell the truth, there is no homogeneity of opinions. There are those who believe that trying to anticipate what is going to happen translates into higher returns, but also those who think just the opposite: that it is impossible to guess what is going to happen in the markets.
Market timing, what do your defenders think?
The proponents of market timing , technical investors mostly use different tools and methods of prediction, as technical indicators economic (New Higs-New Lows, forward line / descent, the oscillator McClellan, the VIX …) or data (yield curve of interest, Kitchin cycles …), to determine the best time to buy or sell.
Its objective is to anticipate the market by studying all the variables that come into play at all times to try to guess what the exact behavior of a financial asset will be . With this information in their possession, they try to buy as cheaply as possible and sell when the price is all the way up, in order to get the maximum profit.
The problem is that guessing what is going to happen in the market does not seem easy, especially if you are not a professional in the financial world. Therefore, if you are an average investor, with a rather zero technical base and little knowledge of the market and the economy, you will most likely use market timing very badly.
The drawbacks of market timing
The detractors of the market timing strategy firmly affirm that it is impossible to anticipate what the market’s behavior will be , since in the short term it is totally unpredictable. They also point out that the market timimg is such a short-term strategy that it turns investment into simple speculation.
In this line of thought, there are numerous academic studies that analyze what is known as the “behavior gap” (difference by behavior).
What they do is study the real return that mutual funds provide to their investors based on the data of capital inflows and outflows. In other words, they analyze the benefit of the same investment for an investor who does nothing (maintains her position no matter what happens) and for another who practices market timing.
The conclusion is that investors who try to guess what is going to happen in the market and, to achieve it, sell when prices fall and buy when they rise, obtain on average between 1% and 1.5% less annual profitability . If they had stood still, enduring the market’s ups and downs, they would have made more money.
Depending on the geographical area in which the studies were carried out (United States, emerging countries, United Kingdom…) and the type of asset ( stocks , investment funds , hedge funds …), the range with the lowest profitability of the investor who practiced market timing ranged from 1% to 6%.
Warren Buffet’s advice that many fund managers don’t want you to know
Warren Buffet , an investment guy who knows a lot more than all of us put together, claimed that no one, absolutely no one, not even himself, was able to foresee what would happen to the price of a stock in the short term.
In other words, what the greatest mutual fund manager in history wanted to say is that it is impossible to anticipate the market . Therefore, the investor who is waiting to choose the best time to invest, will probably end up obtaining a lower return on his portfolio.
In short, if you are thinking of going public, forget about choosing the best moment . Most likely, the best time was yesterday and the second best time is today. Almost certainly, market timing will waste your time and earn less money, so hide your ball to predict the future and invest regardless of the financial situation.
Our particular recommendation is that you disassociate yourself from the evolution of the market and automate your investment . You can achieve this, for example, by progressively investing a fixed amount of money each month (what is known as dollar cost averaging). Whether the market goes up or down is something that you will not care about: you will set your sights on the long term and each month you will invest the established amount of money, no matter what happens in the world.
This will be much easier to achieve if you become a passive investor and therefore do not intervene in the process . Schedule a periodic transfer to your preferred investment fund at your bank and forget about everything else.