Common wisdom today tells us that timing the market doesn’t work. As hard as investors may try, earning big profits by correctly timing buy and sell orders just before prices go up and down is far from easy.
However, some investors can still profit from timing the market in a smaller and quicker way. If you are interested in tempting your fate with market timing, there are some scenarios that could work and might prove to be worth the risk.
- Timing the market is a strategy in which investors try to buy stocks just before their prices go up and sell stocks just before their prices go down.
- It is pretty much impossible for investors to make this strategy work much of the time.
- Investors often underperform the broad market because they make investing decisions based on emotions.
- Investors may buy when a stock price is too high only because others are buying it. Or they may sell on one piece of bad news.
- It is possible to make money in some situations through market timing.
What Does Timing the Market Mean?
Timing the market is a strategy in which investors buy and sell stocks based on expected price changes. If investors can predict when the market will go up and down, they can make trades to turn that market move into a profit.
For example, if an investor expects the market to climb on economic news next week, they might want to buy a broad market index fund or exchange-traded fund (ETF) or single stocks they expect to go up. They could also trade options (which give the right to buy or sell a stock at a set price), take a short position to bet a stock's price will go down, or use other tools to capture profits from market movements.
While this strategy is great in theory, in practice it is almost impossible to make work on a consistent basis. Some investors hit it right every once in a while, but earning big profits from timing the market again and again is a pipe dream for most.
Making Decisions Based on Emotions
Recent research from Dalbar Inc. found that the average equity mutual fund investor earned a return of 26.14% in 2019 while the Standard & Poor's 500 Index returned 31.49%. Based on net purchases or sales from each month of that year, the average equity fund investor guessed correctly whether to get in or out of the fund only three times out of 12.
Investors typically underperform compared to the market as a whole because of emotional investing behavior, like jumping on a hyped stock when its price is high or overreacting to a single news report. “Buy high and sell low” is bad advice, but that is what investors do when they enter trades based on one piece of bad news or excitement over a soaring stock.
Taking Advantage of Small Market Dips
Predicting the timing of the next major market crash may be more difficult than winning at blackjack in Las Vegas, but that doesn’t mean you can’t make a profit when the market dips slightly.
In 2016, the United Kingdom voted to leave the European Union, a move dubbed Brexit. The next morning, on June 24, the Dow Jones Industrial Average and Standard & Poor's 500 Index fell sharply. However, by the end of July, the markets had recovered and then some. The Brexit vote result would have been a perfect moment to swoop in, buy a broad market ETF, and sell a short time later for a quick profit.
Major political events, economic stats, and deal activity can all lead to market overreactions. Like Brexit, they may offer astute investors a chance at a profitable series of trades.
Jumping on a Stock Too Quickly
Early in the summer of 2017, Amazon.com announced a bid to purchase Whole Foods Market for $13.7 billion. The news sent stocks of other grocery retailers down. Many investors worried that Amazon would take major market share from companies like Kroger and Costco Wholesale.
Investors who thought the market was overreacting to the news and quickly purchased one of those two retailers' stocks on the drop had different outcomes. On June 16, 2017, the date of Amazon's offer, Costco closed at $167.11, down from $180.06 the day before. If you had bought at or near that closing price, figuring the worst was over, you would have been wrong. The stock price continued on a mostly downward trend and would not close above $167.11 until Nov. 8 of that year.
On the other hand, if you had bought Kroger at or near its June 16, 2017, closing price of $22.29, you would have had many chances to sell at a modest profit: The stock didn't close below $22.29 until Aug. 24 of that year.
The Risks and Rewards of Market Timing
As you can see, there are real risks and palpable rewards in trying to time the market. In some cases, as with Brexit, a common-sense belief about future market prices will work out to your advantage. In other situations, as happened with Costco after the Amazon news, investors looking to profit from an overreaction are left with a loss for several months.
Because there is a lot of risk in market timing, never invest more than you can afford to lose.
If you have a knack for forecasting ebbs and flows in stock prices and can avoid having your emotions interfere with trading decisions, you may have your share of success through market timing. However, you will almost certainly find it is easier to make gains in your portfolio by buying and holding stocks over longer periods of time.