Should You Try to Time the Stock Market?

One timeworn piece of investing advice is to "buy low, sell high." Sounds easy, but as a strategy, timing the market — anticipating when the market as a whole or a particular security (stock, bond, etc.) is at a high or low — can be dangerous.

What is market timing?

Market timing is an active investment management strategy that involves buying and selling stocks or other investments based on predictions of short-term market movements. People attempting to time the market are generally trying to buy right before values rise and sell right before values go down. The goal is to get investment returns that exceed what the investor would have earned from a passive investing strategy, such as buying and holding a diversified portfolio.

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How market timing works

The main idea behind market timing is to try to predict when a stock, sector or market will rally and when a stock, sector or market will crash so that the investor can buy right before the rally and sell right before the crash. Theoretically this produces maximum gains for the investor, but in practice it is difficult to execute^[0]

For example, if the stock market steadily climbs and hits new highs over a long period, investors may think that a pullback is imminent and try to time their exit with the intention of avoiding a market downturn. If a drop occurs, the next step would be to predict when the market will bounce back, trying to get in beforehand to ride that wave back up.

Investors use different tools to try to predict future price movements.

• Technical analysis, or the study of past market data, such as price trends and trading volume, to forecast future price action.

• Fundamental analysis, which scrutinizes a company’s business prospects and financial statements to project how the stock will move over time.

• Leading indicators, which help investors gauge sentiment and signal what lies ahead for the market.

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Timing the market vs. time in the market

Spending more time in the market, rather than trying to time the market, can yield better results over the long term. Consistently buying and selling at the most opportune time is nearly impossible without a crystal ball. There are real consequences when market timing doesn’t work out.

Pros and cons of market timing

Advantages of market timing

Returns

Market timing attempts to predict rallies and crashes and buy or sell right before they occur. This is extremely hard to do consistently but in theory can produce substantial gains and/or avoid substantial losses for the investor.

Disadvantages of market timing

Risk

Over the course of a year, the stock market trades up and down, and it’s common for investors to encounter various pullbacks. Those pullbacks can be anything from a dip of 3% to 5%, which typically can happen several times a year, or a more significant stock market correction, characterized by a 10% to 20% drop from a recent market high.

Anxiety

Investors may get anxious watching their portfolio values drop in a downturn. In some cases, the urge to avoid losses can cause investors to sell low and then sit on the sidelines until the market rebounds, which means they buy high. This locks in a permanent loss of capital.

Transaction costs

Buying and selling in anticipation of various market changes can mean paying more transaction costs than buy-and-hold investors would pay. These transaction costs can reduce returns.

Taxes

Capital gains are taxable. How much you pay depends in part on whether you owned the asset for less than a year. If so, the profit may be subject to short-term capital gains tax rates, which are generally higher than long-term capital gains tax rates. The additional taxes can reduce returns.

Time-consuming

Timing the market requires keeping a constant watch on market movements. This can require more time than many investors have to spend on managing their portfolios.

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Skill requirements

Timing the market requires significant knowledge of how financial markets and instruments work, an ability to understand what’s happening in the markets and skills to interpret and act on that information in ways that benefit your portfolio.

3 market timing strategies

Every investor wants the best possible return on their portfolio, and some might be tempted to time the market in pursuit of this goal. Weathering the ups and downs of the market can be tough to stomach during volatile times. But these strategies can help investors stay calm, cool and invested.

1. Mind your asset allocation

An appropriate asset allocation is key to reducing investment risk. Asset allocation means spreading investable dollars across various asset classes or categories of investments — such as stocks, bonds, real estate or cash — based upon goals, risk tolerance and time horizon (the amount of time you have to invest).

Diversification takes this one step further, breaking those asset classes down more into subcategories such as by market capitalization (size of a company), geographic location or style (growth versus value-oriented companies).

2. Use dollar-cost averaging

Investors can also achieve better pricing when investing through strategies such as dollar-cost averaging, which means spreading stock or fund purchases out over time, buying approximately the same amount over regular intervals. This has the effect of buying more shares when the market is down and fewer when the market is up, which can smooth out the average purchase price over time.

3. Work with an advisor

Another option is to rely on the guidance of a seasoned financial advisor. Financial advisors help create a plan for reaching your financial goals, recommend appropriate investments and provide ongoing investment advice.