What is Market Timing?
Market timing is the plan of buying and selling the securities based on decisions made by the analysis done by financial investors by various methods of security analysis to gain and earn a profit on selling. It is the action plan to cope with the fluctuations in the market prices.
It has always been at the center stage of traders and analysts to determine share market timings. 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 analysis.
Table of contents
- Market timing is the idea of buying and selling securities depending on decisions taken by the analysis by financial investors through various security analysis approaches to earn a profit on selling. It is the action plan to manage the fluctuations in market prices.
- One may use it for a long-term or short-term investing horizon depending upon the investor’s risk and return preferences.
- One may also use the strategy to enter or exit financial markets or choose between asset or asset classes.
Market Timing Explained
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. One can apply it 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).. One can also use this strategy to either enter or exit financial markets or choose between assets or asset classesAsset ClassesAssets are classified into various classes based on their type, purpose, or the basis of return or markets. Fixed assets, equity (equity investments, equity-linked savings schemes), real estate, commodities (gold, silver, bronze), cash and cash equivalents, derivatives (equity, bonds, debt), and alternative investments such as hedge funds and bitcoins are examples..
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 analysis.
A larger and all-encompassing view of timing the market is difficult to take. However, commodity and forex market timing besides others still holds significance. It provides small yet consistent gains; for others, investing is the mantra in the long run. For some reason, markets have always offered ample ways to trade. Every perspective has its fair share of gains and losses. Hence, it becomes a matter of opinion and experience.
It can be considered good market timing if it has earned returns, making it dwell in suspicious waters. One can safely assume that an accomplished trade over the long run with such strategies is rather tricky, if not impossible.
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Strategies related to global market timings may be based on fundamental analysisFundamental AnalysisFundamental Analysis (FA) refers to the process of studying any security's intrinsic value with the object of making profits while trading in it. The primary purpose of fundamental analysis is to determine whether the security or stock is undervalued or overvalued and thereby make an informed decision to buy, hold, or sell it in order to maximize the potential for gains. 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 future prices cannot be determined.
#1 – Fundamental Analysis
When an analyst performs fundamental analysis on a stock or any security, he puts forward some assumptions that correlate to the timing of the buy or sell decisions about the stock. Market timing becomes the function of his assumed variables and thesis. The more accurate his assumptions, the more impeccable the timing of the trade. Generally, fundamental analysis forms a mid-term to long-term view of its stocks.
#2 – Technical Analysis
Technical analysisTechnical AnalysisTechnical analysis is the process of predicting the price movement of tradable instruments using historical trading charts and market data. is more short-sighted 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.
Suppose an investor, Mr. M, wants to invest in the market for two years. He has the following information: –
- Stock A will gain 20% within ten months from now
- Stock B will lose 12% within six months from now
Based on the above information, Mr. M can make a strategy of buying Stock A before it gains and buying Stock B after it loses. However, the certainty and magnitude of Mr. M’s expected returns will depend upon the authenticity and productivity of the information.
Risks & Restrictions
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 thinks stock prices to be at fair market value and hence makes no distinction between overvalued or undervalued stocks.
- Passive Management – Some investors do not consider investing time in regular market trading. They have long-run investment strategies and consider market timing to be less helpful in pursuing 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. think predicting the market and stock prices are useless. They feel 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.
- When performed with good command of timing, market transactions generate high returns.
- High gains may offset the risks of such strategies.
- One can earn quick and short-term profits.
- It requires constant tracking of market behavior and trends.
- The strategy’s short-term horizon brings tax liabilities into the picture.
- Since profit earnings are quick and short in duration, investors might find it rather tricky to buy and sell at the most appropriate juncture.
Market Timing Vs Buy And Hold
Buy and hold is exactly the opposite of the market timing strategy.
When investors do not believe in the fruitfulness of market timing strategies, they tend to use a technique known as buy-and-hold. This strategy is based on that better market return is possible only in the long investment run. Therefore, it is closely associated with the passive management strategy of investing and opposite market timing strategies. However, one should note that a buy-and-hold investor will not always be passive in security selection. Instead, he will actively choose stocks when he finds them 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 $100 towards the end of the last decade is settling on the consistent $1,500 level mark in recent trades.
Frequently Asked Questions (FAQs)
Market timing only works if different major investors use their strategies and trade on their own time.
Market timing is a theory of how firms and corporations in the economy decide to finance the investment with equity or debt instruments. In addition, it is one of the corporate finance theories and contrasts with the pecking order theory and the trade-off theory.
Market timing is legal and permissible in which investors are involved even though it is a discouraged practice because of its high risk and the very nature of gambling based on chance.
The research indicates that the waiting cost for the perfect investment moment usually increases the perfect timing advantages. Moreover, since perfect market timing is nearly impossible, the best approach is to avoid involving in market timing. Instead, one must initiate a plan and invest as soon as possible they can.
This article is a guide to what is Market Timing. Here we explain its strategies, vs buy and hold along with the risks associated and an example. You can learn more about financing from the following articles: –