Posted on April 3, 2009 - by Jay

On market timing

Photo by Street_Spirit

This is one topic that always attracts a lot of debate and verbal lashes. Value investors are of the view that it is futile to time the market. Over long period of time, studies have shown that you cannot beat market return after factoring transaction costs. This does not mean one cannot have positive returns. It might be possible to generate positive returns but I have enough evidence to believe that it’s quite difficult.

Traders, on the other hand, believe that market timing is part and parcel of “investing”. Well what value investors define as investing may be different from what traders define as investing though, but for now let’s not delve into this yet. Anyways traders believe that those who don’t look at charts and to a certain extent, time the entry and exit are idiots.

Ok, first we should actually define the two different types of market timing that exist.

The first type is looking at daily, weekly, monthly, quarterly or even 1-2 yr charts and try to time the bottom and top. ie buy at the low (as dictated by chart patterns or other signals) then sell at the high. To try to win this game is very similar to playing at the casino. Your chances of winning are usually less than 50%. Nevertheless there are ways to make money even when you are up against the house. The book Fortune’s Formula provide some interesting insights. I hope to discuss some interesting stuff from this book in the future but for now, we are not interested in this definition of market timing. You are at a value investing blog, remember?

Ok, the 2nd type of market timing involves 5-7 years macroeconomic trends and stock market cycles. This is the important type of market timing that we shall focus today.

From 1950 to 2000, if you invest in a stock index (in this post we use stats from the S&P500) and your investment horizon is only 1 yr, i.e. you buy in any particular year and sell 1 yr later, your returns can vary between -50% to +25%.

This means that if you are damn bloody good and started investing in at the bottom of the cycle, (e.g. 1998 to 1999), then your return can be 25%, in 1 yr. And if you are damn suay, and started at the peak of the cycle (like 2007), your return can be as bad as -50% in 1 yr.

However as your investment horizon stretches, the returns tend to vary less and get skewed towards a +ve return. Read more…

Related posts:

1. Timing the Market?
2. Untiming the Market
3. Understanding Stock Market Risks