What is Market Timing?
Market timing is the plan of buying and selling the securities on the basis of decisions made by the analysis done by financial investors by various methods of security analysis to gain and earn a profit on selling and it is the action plan to cope up with the fluctuations in the market prices.
Suppose an investor M wants to invest in the market for 2 years, and he has the following information:
- Stock A will gain 20% in 10 months from now.
- Stock B will lose 12% in 6 months from now.
Mr. M can make a strategy of buying stock A before it gains and buying B after it loses based on the above information. However, the certainty and magnitude of Mr. M’s expected returns will depend upon the authenticity and productivity of the information.
Basis of Market Timing Strategy
Strategies related to market timings may be based on fundamental analysis or technical analysis. Investors who do not perform any of these analyses also tend to make their predictions based on the information that comes out from these analyses. But on the flip side of this is the perspective of some analysts who believe that markets are perfectly efficient because of which the future prices cannot be determined.
#1 – Fundamental Analysis
When an analyst performs fundamental analysis on a stock or any security for that matter, he puts forward some assumptions which correlate to the timing of the buy or sell decisions pertaining to the stock. Market timing becomes the function of his assumed variables and thesis. The more accurate his assumptions, the more impeccable his timing of the trade. Generally speaking, fundamental analysis forms a mid to long term view of its stocks.
#2 – Technical Analysis
Technical analysis is more shortsighted and takes a short to a mid-term view of its subject security. Market timing in such a case becomes the function of historical performance and investor behavior.
The exact opposite – Buy-and-hold
When investors do not believe in the fruitfulness of market timing strategies, they tend to use a strategy known as buy-and-hold. This strategy is based on the fact that better market return is possible only in the long run of investment. It is much closely associated with the passive management strategy of investing and is opposite to market timing strategies. However, it should be noted that a buy-and-hold investor will not always be passive in security selection. He chooses stocks actively as and when he finds worthwhile but takes a long-term position by holding the stocks.
Examples of this strategy are the investors who bought shares in Amazon stocks realizing its future potential about a decade ago. The stock below US $100 towards the end of the last decade is settling on the consistent US $ 1500 level mark in the recent trades.
- Market transactions, when performed with good command on timing, generate high returns.
- The risks in such strategies may be offset by high gains.
- Quick and short-term profits can be earned.
- It requires constant tracking of market behavior and trends.
- It brings into picture tax liabilities because of the short-term horizon of the strategy.
- Since profit earnings are quick and short in duration, investors might find it rather tricky to buy and sell at the most appropriate juncture.
These strategies can be limited by the arguments laid by the following theories: –
- Efficient Market HypothesisEfficient Market HypothesisThe efficient market hypothesis (EMH) states that the stock prices indicate all relevant information and are universally shared, making it impossible for investors to earn above-average returns consistently. Economist Eugene Fama gave the idea of the efficient market hypothesis in the 1960s. – Theorists who believe markets to be efficient consider market timing a less significant factor in trading, thus creating no opportunities for trade. This school of thought believes stock prices to be at fair market value and hence makes no distinction of overvalued or undervalued stocks.
- Passive Management – Some investors do not consider investing time in regular trading in the markets. They have long-run strategies for investing and consider market timing to be less helpful in their pursuit of profits.
- Random-walk Theory – The proponents of the random walk theoryRandom Walk TheoryRandom walk theory states that the prices of stocks fluctuate independently of their counterparts and follow the same distribution. In other words, it suggests that predicting stock prices based on past trends is of no use since the securities often exhibit an irregular performance. consider predicting the market and stock prices to be useless. They consider information supporting fundamental analyses and technical analyses to be futile. According to them, historical prices cannot form the basis of future predictions, and neither can stocks affect each other.
Market timing is the strategy of trading financial assetsFinancial AssetsFinancial assets are investment assets whose value derives from a contractual claim on what they represent. These are liquid assets because the economic resources or ownership can be converted into a valuable asset such as cash. based on the rule of timely buying and selling, and it can be applied to a long-term or short-term investing horizon depending upon the risk and return preferences of the investors. It can operate based on simple or complex forecasting methodsForecasting MethodsTop forecasting methods include qualitative forecasting (Delphi method, market survey, executive opinion, sales force composite) and quantitative forecasting (time series and associative models).. This strategy can be used to either enter or exit financial markets or choose between assets or asset classes.
It has always been at the center stage of traders and analysts. If we take an unbiased view of trading, we might agree that it is one of the more essential factors. An investment made at the right time comes to fruition more easily and requires a greater sense of timing knowledge and analyses in advance.
A larger and all-encompassing view of market timing is difficult to take. For some, It provides small yet consistent gains; for others investing, in the long run, is the mantra. For some reason, markets have always provided ample ways to trade. Every perspective has its fair share of gains and losses. Hence, it becomes a matter of opinion and experience.
A good market timing is only when it has earned returns, making it dwell in suspicious waters. It can be safely assumed that an accomplished trade over the long run with such strategies is rather tricky, if not impossible.
This article has been a guide to Market Timing and its definition. Here we discuss the top 2 types of market timing strategies and examples, merits, demerits, and limitations. You can learn more about Financing from the following articles –