We’ve explored day trading vs long term investing before. Let’s now take a closer look at stock market timing.
Market timing is a strategy that people use to determine when to stay or leave the market, or when to buy and sell their positions in a particular asset class. Active traders try to make money by predicting future moves in the market. Whether or not they’re successful at this depends on their skill, luck and experience.
So why do people day trade or perform market timing? Different investors and traders time the market for various reasons. For some, it’s because they believe that they can beat out average stock market returns, which typically range between 8% to 10% annually over the long term. For others, it’s because they want to protect their positions and reduce risks to their portfolio. And for many others, it’s all of the above!
I’ve seen all kinds of market timing over the years. While many people use online stock trading tools, trade on a daily basis and make high volume trades with small gains per trade, others use a different strategy and simply trade occasionally: their time between trades is long and they time the market as more of a long term strategy. If they sense the market shifting away from its long term trend, they may make a move to either buy or sell.
The Pros of Stock Market Timing
It is imperative to note that trading the market isn’t for everyone. Most investors should stick to their long term investing strategy of investing in diversified funds and ETFs. Better yet, they should invest in index funds or ETFs. For those of you who insist on trading and who’ve studied a particular investment market well, you may want to try out trading by using a “fake portfolio” first, or by investing only a little of your money before you jump in with both feet first into this high risk activity.
If you begin trading without a plan, you’re simply gambling money away. You can always approach trading cautiously and build up your experience over time in order to increase your chances of doing well in the markets.
What are some of the pros of market timing? The main thing here is that by learning some amount of technical analysis, you can engage in some stock market timing in order to make money regardless of the direction the market takes. By following market trends, you can anticipate (using the statistically favorable outcome) what kind of move to make next: this means that you can go long or short and still make money no matter what the market does. If you can do this well, you’re ahead of long term investors who only make money when the market goes up.
Also, if you’re a good trader, you can hedge your portfolio well and manage your risks using market timing methods.
The Cons of Stock Market Timing
Long term investors will tell you that timing the market is an awful idea: that there are only “cons” to performing this activity, and that trading simply amounts to gambling. But I believe that there’s a place in the investment universe for trading — you just have to fit this type of activity by having the right profile and experience of a true trader.
Given this context, I believe that there are some disadvantages to timing the market. One is that you’ll rack up a lot of tax documentation by trading up a storm. You’ll have to account for each transaction you make and it can be a pain to do this if you’re not properly equipped with the right tools. A corollary to this matter is that you’ll have to keep good records in order to know just how well you’re doing and how much you’ll owe the government come tax time.
Finally, I’d say that the main drawback of trading is really inherent in how it works: in order to make money, you’ll have to be right twice — once when you buy and once when you sell. You’ll have to know when the right time is to jump in the market, and when the right time is to jump out. If you aren’t in the stock market during its biggest days (when it makes the greatest gains), you’ll be losing out on big investment returns and your returns over time will greatly suffer. Making such a mistake would spell disaster for your track record as an investor.
A word of advice: if you’re bent on stock market timing and active trading, make sure you do so with your head and not with your emotions. Emotional trading will only ruin your bottom line. Trade as part of a well thought out strategy and not as an impulsive reaction to market movements.