Does Timing the Stock Market Work?

“I never have the faintest idea what the stock market is going to do in the next six months, or the next year, or the next two.”
-Warren Buffett

Stock market timing (or “market timing”) is a strategy under which the stock market investor makes buy or sell decisions based on the prediction of future price moves. The approach is based on aggregate market predictions, rather than the quality or expectations of a particular stock.

Trading v. Investing

Many market timers operate in more of a “trading” than an “investing” mentality, seeking profits by moving in and out of stock positions very quickly to capitalize on the smallest swings in stock prices. Market timers believe they can spot and seize opportunities where stocks are over or undervalued.

While some consider stock market timing to be very close to pure gambling, others believe the strategy is rational in some situations, such as an apparent “bubble” or largely overvalued market. Historically, investors who have avoided very large slides in the market only needed to participate in about 30% of the next upswing in order to match the returns of their buy and hold investing counterparts.

Potential to Miss Out on Big Gains

The question then becomes whether the average investor can follow this strategy successfully and, unfortunately, there is little evidence to suggest that this is the case. In fact, stock market experts like Peter Lynch believe it is foolish to try to time the market, arguing that as stock prices increase over the long term those that move in and out of stocks with market timing strategies often miss out on big gains.

Opponents to the market timing approach point to that the extreme volatility of the market and the fact that if you miss the market’s best-performing days, your portfolio will be in substantially worse shape than if you had just bought and held.

The Buy and Hold Alternative

The alternative to stock market timing, of course, is buying good, solid stocks at good value with the intention of holding onto them for the long-term. Under this buy and hold investment approach, decisions to sell specific stocks are made when changes in company fundamentals dictate that you do so or when you believe the stock has become overvalued.

________________________________________________________________

The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

« The Dogs of the Dow Investment Strategy | Home | The Rule of 72 (includes calculator) »