What Is Market Timing?

Market timing means trying to find the best moment to invest in the market. Timing the market well can maximize your returns, but it isn't easy, and most attempts are likely to fail.

In this post, we'll take a detailed look at what market timing is, its pros and cons, and why it so often fails.

Key Takeaways

Market timing is moving investment money into or out of financial markets, or between asset classes, based on predictions.

If you time the market well, you can maximize returns by buying near the market's lows and selling near its highs.

However, it is hard for individual investors to time the market accurately, and sticking with a long-term investment strategy may be the better choice.

The Concept of Market Timing

Market timing refers to moving assets around based on predictions of whether the market will rise or fall. This includes buying or selling assets, or shifting assets from one sector to another. Market timing is a strategy that grew out of the idea that you can maximize returns by predicting the direction of the market.

Market timing is one of the core elements of active investing, and it is also a basic strategy for most traders. The methods used to decide on market timing can draw on fundamental, technical, quantitative, and economic data.

That said, while many investors and financial professionals believe market timing is impossible, some active traders believe it can be done. Statistically, predicting it accurately over and over again is almost impossible.

Market timing is the opposite of "buy and hold," the hallmark strategy of long-term investing. Long-term investors hold their assets for a long time regardless of market volatility, whereas investors who try to time the market aim to take advantage of short-term market swings.

How to Time the Market, and Its Limits

To time the market, you need to watch it consistently and understand the big-picture trends. During a period of rising interest rates, for example, a Fed pivot or the point when inflation starts to fall could serve as a market timing signal. Of course, the market may have already priced everything in, or it may move in a direction you didn't expect for other reasons.

Timing the market is quite difficult for most individual investors, but it isn't completely impossible. Scalpers who trade frequently, day traders, portfolio managers, and full-time investors sometimes do accurately predict the best time to invest in an asset. But no one can keep predicting market timing accurately time after time.

Pros and Cons of Market Timing

If you time the market well, you can earn bigger returns. Buying and selling at the right moments can boost your profits, and selling your assets when you expect a downturn can reduce your losses. You can also avoid the market's big swings and pursue relatively stable returns.

However, market timing also has a few drawbacks. Because you have to keep monitoring market trends, it requires constant attention and effort. Frequent trading also drives up transaction costs and fees, and profits from short-term trades may be subject to higher tax rates. Finally, since it's hard to predict the exact moment to buy or sell, trying to time the market can be far more stressful than you might expect.

Criticism of Market Timing

Market timing strategies often draw criticism. Nobel laureate William Sharpe, in his study "Likely Gains from Market Timing," found that you would need to be right 74% of the time to profit from market timing. That is a level of accuracy most investors find hard to achieve.

In particular, most individual investors can't watch the market consistently and tend to act on emotion, so they are more likely to buy at the top, when market sentiment is at its peak. Without enough attention to and understanding of the market, getting market timing right may be next to impossible.

What's more, even most professionals can't predict the market accurately on a consistent basis. For example, in 2017 the Center for Retirement Research at Boston College reported that funds that attempted market timing underperformed other funds by as much as 0.14 percentage points.

In addition, according to a Morningstar study, only 23% of actively managed funds outperformed funds pursuing a long-term approach over the 10 years through June 2019. This suggests that most investors fail to beat the market over the long run.

The Main Risks of Market Timing

One of the biggest risks of market timing is that you may miss the market's most important moments. Accurately predicting market highs and lows is extremely difficult, and if you pull your money out during a downturn, you may not be properly invested when the market turns back up.

In fact, according to Boston-based research firm Dalbar, if you had stayed invested in the S&P 500 from 1995 to 2014, you would have earned an annual return of 9.85%. But if you had missed the market's 10 best days, your return would have been just 5.1%.

Wrapping Up

A market timing strategy means trading by predicting price lows and highs. Put simply, it's a strategy of buying when prices are near the bottom and selling when they're near the top. In most cases, however, getting that timing right is extremely difficult.

Market timing may be appealing in theory, but pulling it off successfully in practice is very hard. For most investors, it may be better to ride out market volatility with a long-term investment strategy.