The Market Timing Debacle

Investors looking to avoid the sharp downturns or to benefit from recovery rallies during a secular bear market via market timing are bound to fail.

One intuitive response to the cyclical swings of a secular bear market – such as we have seen lately –  is simply to try to time the market via active trading designed to buy (relatively) low and sell (relatively) high(er). Such market timing is a strategy of financial management which attempts to predict future market price movements over the near and intermediate-term. The prediction may be based on an outlook of market or economic conditions resulting from either technical or fundamental analysis, or some combination thereof. Unfortunately, there is very little evidence that such an approach works.

A market timing strategy is based on one’s outlook for an aggregate market, rather than for a particular financial asset. Without reviewing all the research, suffice it to say that both institutional investors (more here, here and here) and individuals consistently fail as market timers. As John Kenneth Galbraith famously pointed out, we have two classes of forecasters: those who don’t know and those who don’t know they don’t know.  Or, as Yoram Bauman, the Stand-Up Economist, has said in a similar vein, economists have forecast nine out of the last five recessions (for an interesting look at forecasting error, see here).

Where “true value” levels reside is not all that difficult to figure out, at least generally, but when and how the markets move is exceedingly difficult to ascertain and extremely frustrating for the trader. As Meir Statman pointed out in a recent Institutional Investor column: “Too many [investors] believe that they have a good chance to win the investment game, when, in truth, they are overconfident and unrealistically optimistic.”

Over most time periods, market movements are dominated by “noise” – random events that cannot be predicted with any degree of reliability.  As a result, most of the time, making shorter term market timing moves is a loser’s game – with outcomes dominated by luck rather than skill, and high transaction costs.

To illustrate, for most of us tennis is a loser’s game. We do not possess the skills to play well consistently.  Trying harder to make great shots only makes matters worse.  Most of us are far better off simply trying to keep the ball in play rather than trying to outclass an opponent.  If we keep the ball in play we give the opponent the opportunity to make errors.  That’s a loser’s game — the results are dominated by what the loser does.  On the other hand, professional tennis is a winner’s game, with the outcome based predominately upon the winner’s better shots.  A pro needs to do more than just keep the ball in play to succeed.

Since there is so little evidence that market timing works, trying it is like a week-end tennis player consistently trying to hit winners. Market timing is a loser’s game.  It simply does not work.

3 thoughts on “The Market Timing Debacle

  1. Pingback: The Indexing Dilemma | Above the Market

  2. Pingback: 2 Reasons to Question “5 reasons to ignore top 10 stock lists” | Above the Market

  3. Pingback: The Value Project (3): The Value Proposition | Above the Market

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