How to Understand Stock Market Timing

Can a Trader Time the Stock Market?

Understanding stock market timing is a tough proposition, because you have to be a stock market expert to truly understand the complexities of stock market timing. In fact, there are many money experts who would say “stock market timing” is little more than gambling, so even the experts don’t agree on the advantages and disadvantages of market timing.

With that in mind, I’ll try to give you a basic understanding of the principles of stock market timing and what its proponents (and opponents) believe it can do for you.

What Is Stock Market Timing?

Often called simply “market timing”, stock market timing is the making of buy/sell decisions on financial assets by predicting future market prices. This prediction might come from a technical analysis of market trends or a fundamental analysis of market trends, but the idea is that you are making buy/sell decisions based on your analysis of the aggregate market and not on your analysis of a particular company’s stock or financial assets.

In essence, stock market timing is based on predicting bubbles and the bursting of bubbles in the market. Someone using stock market timing tries to predict a bear or bull market and then buys or sells assets based on those assumptions.

The “market timing strategy” is usually opposed by stock traders who advocate or practice “buy and hold” strategies. These traders tend to buy stocks in companies they believe are sound (or better put, have undervalued stock) and then hold these stocks over a long period. Buy-and-hold stock traders will “reposition” themselves occasionally, but they seldom get involved in day trading.

Pros and Cons of Stock Market Timing

Proponents of stock market timing would argue that all stock trading is based on an analysis of which way the broader market is heading. They argue there’s nothing strange about a market timing strategy and that a strategy based on analysis of the financial resources available for investment along with investor confidence has its place in stock trading.

Opponents of stock market timing, on the other hand, argue that bubbles can last for years, just as economic downturns can do the same, and therefore trying to predict when bubbles burst is pointless, if not hazardous. They would argue that one should spend one’s time analyzing particular companies, to see whether that company is sound or not and to see whether their stocks are undervalued or overvalued.

Stock Market Timing Studies

Studies done in the 2000s indicate that investors are more likely to buy high and sell low, which tends to be in direct contradiction to the stock market wisdom that you sell high and buy low. That is, the studies show that people are more likely to buy when buying is happening and more likely to sell when prices are dropping. Instead of bubbles tending to burst quickly and downturns tending to turn up quickly, traders on the stock exchanges tend to follow the herd.

That is, stock traders aren’t rational all the times. Stock market timing suggests that people will follow the rational path and therefore market timing experts can make money by predicting rational readjustments of the whole market. These studies would seem to show that market timing is not the soundest of strategies to employ when stock trading.

Understanding Stock Market Timing

Once again, since the recognized experts of Wall Street cannot agree on whether stock market timing is a viable investment strategy, I won’t give a definitive judgment here. The current Big Recession would indicate that purely rational markets do not exist.

At the same time, it appears that small-scale investors are discouraged from trying to time the markets by their brokerages, while the same brokerages execute market timing strategies for the benefits of larger, institutional clients. This would indicate that market timing does have a place in market strategy, though the conflict of interest inherent in this dichotomy and the role of the retail clients in upholding markets while the institutional clients time out have not been fully explored or explained.

In the end, the data is incomplete. Whether the stock market can be “beaten” by stock market timing or instead by anything other than luck is still a matter of controversy.

Timing the Stock Market in My Own Opinion

Personally, I believe a really skilled analyst can time the stock market, but that person has to understand the underlying condition of the economy, the general level of money resources left to invest and the collective consciousness of the stock market trading community. In other words, the analyst has to be able to analyze the general state of the economy, while also being a master of collective psychology.

Even then, stock market timing isn’t a sure thing, because as irrational as one human mind can be, history has shown that the collective human mind can be even more irrational. Studies have shown that people are more likely to do things and take risks in large groups that they would never do as an individual, while it’s a common belief that just the opposite is true.

Therefore, rationality does not always command the money markets. Predicting irrational behavior becomes much more difficult than predicting rational behavior, because it’s by definition an irrational exercise. Careful study might show what is most likely to happen in the near future, or almost certain to happen in the far future, but that does not mean a certain collective reaction is sure to happen in the near future.

Therefore, stock market timing remains more of an art than a science.

That being said, there are genius artists in all different fields of human endeavor, so it’s not out of the realm of possibility that a genius artist of stock market timing exists out there.

If you’re just jumping into the stock market and you think you’re going to be able to time the stock market, though, don’t try. Applying a buy-and-hold philosophy is the more rational way to approach your stock market portfolio.

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