Market Timing

Besides investing all at once, periodically or sporadically, some investors believe market timing is the answer.  With market timing, a formula is used to signal to buy (get into the stock market) or sell (get out of stocks and into cash equivalents).  The most popular formula is the 30-day moving average of the DJIA.  The 30-day average is plotted against the daily price of the Dow.  When the daily price line moves above the 30-day average, a buy signal is triggered.  Conversely, when the daily line moves below the 30-day average, a sell occurs.

There are hundreds of different market timing programs.  Some programs use the Dow, other the S&P, still others use a couple of dozen "indicators" (e.g., housing starts, unemployment, the price of gold, etc.). For any given period of time, there is a formula that works--it will get the investor out of equities somewhere near the market top and get him back in somewhere near the market bottom (out of cash and back into stocks).  Unfortunately, no one knows what current or future formula will work next time.  This is why virtually all market timers fail, regardless of how much they pay a timing service or complex the formula. 

Domestic and foreign studies repeatedly show market timing does not work.  In fact, no study has ever shown that market timing has worked.  One mutual fund advisory service looked at 20 years of data and assumed that in each quarter, an investor chose to either own just stocks or just T. bills.  A market timer who picked the best performer half the time (40 out of 80 quarters), still ended up way behind the S&P 500 investor who bought and held. 

Statistically, the market timer only began to beat the buy-and-hold investor when the right choice was picked 65% of the time.  In other words, the timer had to choose between stocks and cash and be right two out of every three picks (quarters) before the strategy worked.  The numbers would have to be even higher if tax consequences were factored in.