What Is Market Timing?
Buy low and sell high. This age-old advice for making money in the stock market was an early endorsement of market timing. But there’s a reason this saying is sometimes repeated facetiously: It isn’t as easy as it sounds.
How Does Market Timing Work?
Market timing is an active investment strategy where an investor or money manager shifts money in and out of the market or from one investment to another in an attempt to exploit anticipated short-term price movements. Market timing can involve transferring between equity sectors and asset classes, or even liquidating some or all of one’s risk assets in favor of cash. The goal is to achieve returns superior to those that buying and holding an index or diversified group of investments would deliver.
Markets tend to spend much of their time rangebound, making modest moves both up and down. They might generate most of their gains (or losses) during the relatively brief periods when they sustain a trend. Some investors view this behavior as an opportunity to try to beat the market by staying invested during the uptrends and exiting risky investments ahead of predicted downtrends to avoid some of the losses.
Investors can use technical (based on patterns of prices or volume), quantitative (mathematical or statistical methods) or fundamental (studying financial statements or business positioning) analysis for market timing.
Does Market Timing Make Sense for You?
Market timing involves actively trading in an effort to take advantage of short-term price fluctuations. Trying to sidestep the occasional market selloff or capture quick, short-lived rallies in an industry or sector has the potential to increase returns, but frequent trading based on predictions also comes with risk.
There are several roadblocks to success for this strategy. The first is the higher transaction costs and perhaps fees you’ll absorb when you trade more actively. Then there’s the potential for missed opportunities. Some of the top trading days end up occurring during periods of greater volatility. If you exit your positions during a sharp selloff that proves temporary, you very well might miss a subsequent recovery and rally. By comparison, a buy-and-hold strategy involves holding investments for a long period of time regardless of market fluctuations. And with a periodic investing strategy, such as dollar-cost averaging, you invest funds at regular intervals on a set schedule.
There are also tax implications for successful market timing: Every time you sell an asset, you’ll realize any gains made from that investment, which is typically a taxable event. And if your holding time for an investment is less than one year, your gains will be taxed at the higher rate for short-term capital gains. For this reason, many investors limit their market timing to tax-deferred accounts like an individual retirement arrangement (IRA) or 401(k). Talk with a tax professional about how capital gains taxes could impact you.
As with any complex skill set, acquiring the knowledge and experience to master market timing can take years, so think about whether you have both the desire and time to do so before pursuing this strategy. Decide how practical a market timing strategy is for you, keeping in mind your financial goals and risk tolerance, and fully evaluate the various factors that affect the potential for profitable short-term trades. Don’t let short-term emotions about investments disrupt your long-term financial objectives. And, lastly, consider working with an investment professional to help you determine the best investment strategy to achieve your individual financial goals.
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