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Can investors time the markets to their advantage?

Manvi Agarwal
·6-min read

''The economy will perform poorly over the next few months. You must get out of the markets now and consider buying later.''

''Mr. Financial expert thinks the economy has bottomed out. Now might be a good time to buy.''

Switch on any Financial news channel you can see hundreds of so-called experts predicting the trajectory of the stock markets. They are all busy trying to time the stock markets, its tops and bottoms.

Simultaneously, you have some of the successful investors saying:

“We wish we had perfect market timing (as well as the ability to fly). The reality is that no one does or ever will.’’ - Seth Klarman

“After nearly 50 years in this business, I do not know of anybody who has [timed the market] successfully. I don't even know of anybody who knows anybody who has done it.’’ - Jack Bogle

Now, this can easily confuse you. On the one hand, you have some of the most successful investors claiming that timing the markets is a futile exercise and on the other, you have these news channels rambling on about when to invest (investing at the right time). So, what do you do? Whom to believe?

Let us cut through all this noise and understand some facts about timing the market. Is timing the market possible? How often can you, an investor, time the market successfully? And how can you use some elements of market timing to work to your advantage?

Timing the markets - Is it even possible?

Market timers believe in outperforming the markets by buying at market bottoms and selling at market tops. A strategy good on paper and seems simple enough to work. But does it?

Unfortunately, timing the stock markets does not work. And there ample amount of data to back it up.

Think about it. To successfully time the markets, you have to get it right on two different accounts: buying as well as selling.

“In my experience, most people who are lucky enough to sell something before it goes down get so busy patting themselves on the back they forget to buy it back.’’ - Howard Marks

So for instance, if you decide to sell today (which might be the right time), you must re-enter, at the right time. Because if you miss the next rally, your decision to exit at the right time had no value.

Several investors are under the impression that they have cracked the code and timed the market tops and bottoms. But they are wrong. There is no holy grail to help predict market movements. And how can there possibly be? Market movements are effectively a function of investor emotions, not fundamentals. It was evident in the stock markets movements in the past few years where, despite dwindling demand and weak economic indicators, the stock markets were flying. And you cannot predict investor emotion, let alone time it.

Furthermore, there is an experiment conducted by a group of researchers on timing the markets. They tracked down the value of an investment made in the best possible time and in the worse possible time, all within a year. And oddly, the result was not staggeringly different. The value of the investment made in the worst possible time was 80% of the value of the investment made in the best possible time. Implying that not only can you not pick the perfect day or time to invest, but also there is not a whole lot of upside from achieving that. Hence a better and proven strategy is to buy and hold.

Buy and hold - a proven strategy

Staying invested i.e., buy and hold, is the name of the game. It is a much safer strategy that works almost every single time with a whole lot of upside to it. And what gives it more impetus is the reinforcement it receives from most of the successful investors across the world.

But much like any other investment strategy, this too has its pros and cons. Buying and holding is neither stressful nor time-consuming. It does not require continuous juggling or monitoring and allows your investments to ride the market ups and downs, giving them enough time to multiply.

But on the flip side, if you are wrong, it can take you a while to realise it as certain investments can underperform for years. Moreover, markets sometimes trade sideways for years where only actively managed funds generate returns. But investors can easily side-steep this issue by monitoring their portfolio actively. And hence with all its negatives, buying and holding is the most preferred, proven and successful strategy by experts across the world.

Using some elements of timing the markets to your advantage

But just because you cannot time the markets, does not mean you cannot use some of the elements of market timing to your advantage. Primarily as taking advantage of occasional opportunities presented by the market is not necessarily the same as timing the market.

Since emotions drive price movements, this element plays a large role.

Let us understand this better. Prices tend to rocket when investors are fearful of missing out(get greedy), and bottom out when investors fear losing money. Now, this is when patient investors can benefit, analysing and identifying attractive or overbought stock prices.

So for instance, when everyone was fearful during the Covid-19 crash, a lot of successful investors recommended buying strong companies at discounts rather than weak companies at deeper discounts. It didn't matter when the markets would rebound (timing), if you had enough savings for an emergency, it was a great time to buy stocks.

But this strategy, buy and hold, requires a lot of patience and if I might dare say courage. Because being a great investor involves being different. So when everyone was fearful and uncertain during the Covid-19 crash, you needed the courage to go against the tide and invest.

Peter Lynch, in his book in 1986, wrote that the worst time to invest in the markets is when you visit the barber and he too shares some stock tips with you. Or when you attend a party, and the hottest topic of discussion is the stock markets. Essentially, implying that when everyone is greedy, you must be fearful and take risk off the table. It was true back then and still holds.

Howard Marks, the co-chairman and co-founder of Oaktree Capital Management, believes you can minimise risk near market peaks and bottoms by studying how the economy, markets and investor psychology move in long cycles of expansion and contraction.

To conclude:

Even though the probability of you timing the market right every single time is low, you can take advantage of the stock markets when investors become irrational. As sometimes, investors do punish the stock markets more than necessary. So as an investor, look for high bullish or bearish sentiment or a shift in perception from positive to negative and vice versa. This will present you with a great opportunity to buy quality companies at discounts.

But when it comes to timing the market tops and bottoms, no matter how confident you are of a market call, there is a good chance you will be wrong. And so, the most important thing with any market timing strategy is to weigh in your risk-reward ratio. So, on the off chance that you are wrong, you can at least justify your losses.