Timing the market: How does it work?

30 August 2023 by National Bank Direct Brokerage
An experienced investor trying to time the market with their computer

Market timing is all about closely watching the markets and buying low and selling high. Whether it is more effective than other strategies, such as 'buy and hold', is up for debate. However, it is certain that investors who choose the approach must put in considerable time and effort. Even then, the strategy may not work out as planned.


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What is market timing?

Market timing is an investment strategy where market participants make buying and selling decisions by predicting the price movements of a financial asset. Investors use market timing to outperform the market by buying when markets are bearish, and selling when they become bullish and start going up in value. This approach is favored by financial professionals like day traders and portfolio managers who can devote their time to analyze economic forecasts and predict market shifts with a high degree of confidence.

Understanding market timing

Market timing can apply to both long- and short-term investment strategies. Since the timely buying and selling of financial assets based on predicting price fluctuations can be tricky, it is best left to investors with specialized financial training.

These investors are typically experts who decide when to buy and sell securities based on economic forecasts and chart analysis, or even intuition. Nevertheless, few have been able to predict market shifts consistently enough that they gain a significant advantage over those using a buy-and-hold investment strategy.

Long- vs short-term market timing

Market timing is often associated with short-term trading strategies that are used by professional day traders, and full-time investors. It can also be applied to a long-term approach to predict future market trends that target a particular industry or sector. Compared to a standard long-term 'buy and hold' approach, market timing relies heavily on using sophisticated analytics to evaluate and predict potential losses and short-term shifts in economic conditions.

Is market timing for all investors?

Market timing is not suited to those starting out or those new to self-directed investing. It is difficult to gauge and predict the future direction of the market. Given that market timing relies on a significant amount of analysis, it is complex. As a result, for the average investor, it will typically generate smaller returns than more passive investment strategies. Investors using market timing to coordinate market entrances and exits usually underperform compared to investors who remain invested.

A graph showing the S&P/TSX Total return

Market timing analytics

Experienced investors using a market timing strategy rely on several different types of analysis to make buying or selling decisions:

1. Fundamental analysis

When performing fundamental analysis, an analyst considers certain assumptions regarding variables that affect buying and selling decisions that range from macroeconomic and sector analysis to looking carefully at company-specific details.4 Market timing is the mathematical function of these variables and is used to establish the most accurate timing to make an investment decision. It is typically applied along a mid- to long-term time horizon.

2. Technical analysis

In technical analysis, market timing decisions are based on the stock's historical performance and past investor behavior. By reading and interpreting the past behavior of a publicly traded stock, investors use technical analysis to predict the future direction of the security. Technical analysis is generally used for making decisions along a short- to mid-term investment horizon.

3. Relative strength index (RSI)

The relative strength index (RSI) records the current and historical strength and weakness of a stock based on closing prices during a fixed period of time. RSI charts the rate and extent of a stock's price movements and signals investors to buy when the security is oversold and sell when it is overbought.

Advantages of market timing

Have you heard the expression, 'the higher the risk, the higher the return'? For those with the right level of expertise, such as professional traders or fund managers who keep their eyes on the market 24/7, market timing offers some very specific advantages:

  • When it works, it can be used to maximize profits and to offset the associated higher risks with higher gains.
  • It allows traders to limit the effects of market volatility.
  • It allows traders to reap the benefits of short-term price movements.
  • Using low-cost trading platform like NBDB's $ 0 commission lowers transaction costs on high volume buying and selling.

The limits to market timing

For a committed day trader, market timing may be a helpful strategy, but for those who have day jobs and are not tethered to a stock trading platform all day long, the risks and opportunity costs are high. Market timing remains controversial primarily because evidence suggests that over the long run, it isn't that much more successful than a buy and hold approach, built on a considered and diversified portfolio.

Some of the problems of market timing include:

  • Requiring a trader to consistently follow up on market movements and trends and commit significant time and energy to the process.
  • Generating higher transaction costs and commissions on most brokerage platforms or services because of the high volume of buying and selling.
  • Requiring more work reconciling tax implications during filing periods, particularly if the investor is not using a tax-free account.
  • Precisely timing market entries and exits is extremely difficult, even statistically impossible over the long run.

Though there is always the possibility of a significant payout, repeated success is unlikely because the limits of market timing simply increase the risks that are already built into the investing process. Since market decisions can be driven by emotions and market conditions can get volatile and unpredictable, taking a long-term and cautious approach is usually the best strategy.

Though not impossible, timing the market can be challenging: it yields mixed results and requires a solid understanding of market and economic conditions and analytics. For those with day jobs or starting their journey as independent investors, market timing isn’t an optimal investment strategy. Instead, passive investing strategies built on a diversified portfolio of assets remains the best way to limit risk and grow your money.

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Key Takeaways

  • Market timing is a strategy based on predicting the price movements of a security and is often compared to buy and hold investing.
  • It is an approach favored by financial professionals like day traders and investment experts who can devote the time to analyze economic forecasts and predict market shifts with a high degree of confidence.
  • A market timing strategy relies on several different types of analysis that include technical and fundamental analysis and the RSI index.
  • Statistics suggest that, over the long run, market timing strategies underperform compared to a buy and hold approach.

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