If you had the ability to know for sure what’s going to happen in the future, you’d be a billionaire. Now we know it’s not possible to be able to predict the future, but still, people are confident that they can make money trying to time the market. We break down the terminology and offer our insight on this topic.
Timing the market is an active strategy where investors buy and sell stocks based on their predictions on stock price fluctuations. It is moving in and out of the market to try to make a profit. Investors buy a security right before they expect an increase in stock price, or sell when they think the stock price will drop. If they can predict the movements correctly, they can earn a profit from this change. On the contrary, time in the market is a term used for an investor practicing a passive, buy and hold strategy. You can read about the differences between an active vs. passive strategy here.
There are many different tactics that investors use to try to accurately time the market. A common one is to try to profit from the public response to news. People tend to overreact to news, and this approach works by capitalizing on the overreaction of the news. Take for example the infamous tweet from Elon Musk: “Am considering taking Tesla private at $420. Funding secured.” He tweeted this during market hours, where TSLA shares jumped from a pre-tweet price of $355 up 11% by the end of day to $379.57. When the stock price increases because of overreaction to news, an investor using the timing the market strategy can short the security at its peak until the security returns back to its intrinsic value. There were many questions remaining on whether or not funding was in fact “secured”, and to much skepticism, Musk added that a final decision has not been made. Throughout the next few days, the TSLA stock price went down as much as 10%. An investor who shorted the stock at its peak would have gained tremendously from the overreaction of news. In theory, since there will be emotional biases on the market, timing the market works if you can capitalize on it. Knowing that there are many others who make poor decisions and overreact to news, you can capture small profits when this occurs in the market.
Investors can also use technical or fundamental analysis to try to catch a profit out of the market. They look at features such as the past prices and the intrinsic value of the stock, to determine whether or not the particular security is undervalued or overvalued. Taking advantage of the small bumps in the market allows you to be able to capture profits.
Now that is not to say that market timing does not have its risks. In terms of if this strategy works or not in the real world, there have been many studies conducted that suggest that market timing does not work as a long-term strategy. There is a bigger risk involved with timing the market. An investor could successfully time the market a few times, but to be able to consistently is a different story. Unsuccessful timing creates big hits in the investors’ portfolio. There are various resources that show people who try to buy and sell repeatedly are less successful than those who stay fully invested over the same period of time. The timing the market strategy also requires you to be an active investor constantly. This takes up a lot of time and energy and can be troublesome to do over a longer period of time. There are also transaction costs and tax implications that you need to consider as an active investor, which reduces your return on investment (ROI) significantly.
Now, we bring back the old-age adage of “don’t put all your eggs in one basket” –the one basket being market timing. Investors that are seeking to profit from market timing may suffer a loss. A loss comes from the risk of attempting to time the market. It is good practice to have a portfolio that does not solely rely on market timing stocks; a good blend of different strategies will diversify the risk. It is hard to be consistently right about the market, especially since you are predicting. Knowing the risks involved with market timing and your portfolio management style can help determine whether or not market timing will work for you.