What is market timing? Some investors seek the highest highs and lowest lows, but you can't predict market prices. Here's why value investing works anyway.
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If you've watched the stock market for very long, you've noticed that stocks have seemingly random ups and downs. One day a stock will be up and the next day it'll be down. Most stocks are pretty stable (most stocks worth owning are predictable over time), but a stock might swing a few percent here and there over a few months.
What is Market Timing?
Some people think they can be very clever and buy when the market is at its lowest and sell when the market it as its highest. If they can pull this off, they'll squeeze every last bit of value out of their investing dollars. To lose even a possible percentage point of gain is disheartening.
This is market timing: attempting to predict where investments will go in the future by analyzing the technical moves of stocks (statistical models of how investors tend to behave) and economic focus. There's some merit to technical investing, but the goal of timing the market is to identify the gyrations of the market know when it's at a low point and when it's at a high point. If you can do that—if you can structure your trades so you buy at the lowest point and sell at the highest point—you can, in theory, maximize your potential returns.
Does Timing the Market Work?
Read enough about investing and you'll hear aphorisms like "Sell in May and go away." It's an aphorism—and you can and should distrust simple sayings like this—but many, many people scour historical market data for patterns, especially in the big indexes like the Dow Jones, S&P 500, and NASDAQ. Some people do find patterns, but the human brain is so good at recognizing patterns that sometimes it finds patterns where they don't exist.
There are structural patterns in the market. Toward the end of the year, a lot of big funds do sell to capture profits, take tax losses, and to rebalance their holdings. As well, a lot of stockpickers take vacations in August, so the volume of stocks can be lower in that month than other months. Finally, a lot of companies which make most of their money around the holiday season (retail stocks in particular, technology stocks which sell to retailers) have poor earnings for three out of four quarters of the year.
You could even go so far as to analyze what happens to stocks when their companies announce dividends. Do people bid up the price before the ex-dividend date buy buying more shares and then sell after the ex-dividend date?
You can know all of these patterns, but can you translate them into specific predictions about the motion of any stock? Good luck! If you're right, can you get a percentage or two of profit? (Remember you may have to pay steep taxes on short-term investments.)
Market Timing and Value Investing
Value investors are always looking for bargains. Why not try to pick up another extra couple of percent by delaying a buy or a sell? It seems like an obvious tactic.
The problem is, as usual, that it's difficult to predict the market over the short term. Over the long term, a company that earns money reliably will be worth more in the future than it is now. You can even calculate the value of a business company based on projected future earnings.
Consider your options. If you find a company at a good price and wait to buy it, thinking that you may be able to get a better price in the future, you might miss out on a bargain now. (What if the price never drops? What if you keep thinking the price will go lower?)
What if you're trying to sell at the absolute top of the market? How do you know how high things will go? If you've done your value analysis, you know when a stock is overpriced. How can you predict how irrational other investors will be and when they'll come back to reality? This is another example of the risks of penny stocks; you're waiting on hypothetical sellers to be more foolish than you are.
Value Investing Preaches Patience
It's better to own a great company at a decent price than a decent company at a great price. It's no success to find a bargain simply for the sake of finding a bargain. You need a plan. Why do you want to buy shares of this company? What about the company makes it worth owning? Does that change if the price goes up a couple of percent or down a couple of percent?
You don't have to wring every dollar of potential profit out of the market. If timing the market is keeping you from making good returns, then your strategy is already failing you. There's always a reason not to buy yet, but people who never buy stocks will never make money from them.