Last Updated on December 2, 2024
Overview – Trying to Predict What Markets Will Do Next
Many investors have probably heard the saying “buy low, sell high.”
At a glance, this makes a lot of sense: buy investments when prices are down, wait for the prices to increase, sell the investments, then pocket the proceeds (i.e. the capital gains) from the sale. Rinse and repeat, and soon you’ll find yourself swimming in all the money you’ve made. Sounds easy enough, right?
As simple as this strategy sounds, it doesn’t take much thought to understand the implications of this “straightforward” advice: the major assumption being made is that an investor knows exactly when an investment’s price will reach its lowest point (without any further decrease) and when it will reach its maximum (without any further increase).
No investor can say with full confidence they can accurately predict when those absolute highs and lows will occur. Despite this, many investors still attempt to predict future market movements, only to be left disappointed and with less money in the end due to the speculative nature of market timing.
Instead of trying to predict what the market’s next move will be, investors are usually better off trying to spend as much time in the market as they reasonably can.
Is Market Timing a Valid Investment Strategy?
Imagine you wish to purchase 100 shares of a certain stock, which is currently selling at $60 a share. Disregarding any commissions, you’re not exactly comfortable with the idea of spending $6,000 all at once. So, you decide to wait a bit longer until the price drops to around $55, which will save you $500.
You wait one week, and the price increases to $62. You wait a few more weeks, and the price drops to $60. Eventually, weeks turn into months, and months turn into a year, and not once did the price drop to $55. All that waiting, and in the end, you end up doing nothing as you desperately held onto the hope that “the price will eventually go lower”.
Whether they’re looking to purchase or sell investments, many investors want to extract the most value they possibly can from these transactions. After all, no investor is excited about the possibility of overpaying or underselling. How do you feel when you buy something, only for it to go on sale a few days later, or when you sell something only to come across another buyer who offered more money?
While these concerns are legitimate, attempting to time your transactions in anticipation of the “perfect” price isn’t the way to go about appeasing them. That’s because nobody knows what the future prices of investment instruments will be.
Sure, some price ranges can be reasonably estimated, but unless you have the power of clairvoyance it’s impossible to predict when a specific price will be reached, and when.
Market timing is, for the most part, a largely ineffective strategy because it relies so heavily on many unknown factors, and as a result, is also wildly inconsistent when it comes to achieving the outcomes you want. The worst part is that there’s very little, if anything, that can be done to reduce this uncertainty. Are you really going to implement an investment strategy that relies so heavily on guessing?
Lots of very smart people have developed complex mathematical equations and models to try and predict the future movements of financial markets. The details of these mathematical tools are far beyond the scope of this discussion, but some investors are lulled into believing that these equations and models will work because of their apparent complexity.
The reality is there is no universal equation or technical kit that can accurately predict future investment prices with absolute certainty. It also doesn’t help that investors are flooded almost daily with expected earnings, projected investment prices, and many other predictions – it’s very easy for an investor to see these predictions and proceed to assume they must be accurate because a major brokerage or investment bank published the data.
Try as hard as you want, but market timing will always be an exercise in futility, and is better off not being considered a valid investment strategy to begin with.
Dollar Cost Averaging (DCA): An Alternative to Timing the Market
Despite the futility of stressing over short-term price volatility, many investors are still wary of committing a large amount of capital upfront fearing that the price may vary wildly in the near future, for better or for worse.
Individuals who do not want to exhaust all their capital all at once can do something called Dollar Cost Averaging (DCA). Dollar Cost Averaging is simply the practice of purchasing units of an investment with an earmarked amount of money over a specified period until the entire sum of money is completely spent.
For example, imagine an investor who wishes to purchase $10,000 worth of stock, but they do not want to commit all that capital right away due to fears of volatility. Instead of spending all $10,000 in one purchase, they can instead choose to purchase $1,000 worth of stock every month over a 10-month period.
The number of shares purchased each month will vary due to changes in the stock price, but the amount of money spent will always be the same. The goal of DCA is to minimize the impact of volatility: instead of attempting to time the market in hopes of purchasing at the lowest price possible, dedicating a specific amount of capital over a pre-determined period will mean that some shares are bought at a low price, while others will be bought for a slightly higher price.
The result is the average price per share will fall somewhere between the highest and lowest prices over the spending period.
DCA is one simple yet effective method that can prevent investors from succumbing to the temptation of wanting to time the market. Instead of waiting for the “perfect opportunity”, DCA forces an investor to follow through with their plan to purchase a specific investment, slowly building up their position until all the capital allocated for that investment has been spent.
Time in the Market – The Opposite of Market Timing
If you’ve pursued any sort of endeavour for a long enough time, then chances are you’ve experienced your fair share of ups and downs. Despite these, you know that these highs and lows are but a fleeting moment and that in the grand scheme of things ultimately won’t mean very much.
Similarly, any investor that has years of experience to their name and has encountered all sorts of major financial/economic/global events understands that the price fluctuations that take place on a daily basis ultimately don’t amount to much. To them, they usually don’t care how the price of an investment changes every minute, but they certainly care about how it changes over the long term, such as year after year.
Attempting to time the market can lead to some money being saved and larger-than-expected gains here and there, but given how notoriously difficult it is to time the market correctly, let alone doing so repeatedly, the savings/gains you get ultimately don’t matter a whole lot over the long run.
Are you really going to try and time the market to potentially save $100 on a purchase, or to squeeze out an additional $80 in capital gains, every few weeks, if not months, at best?
By spending as much time as you possibly can in the market, that is, maximizing the length of your investing career, you stand to potentially gain so much more in the long run. The amount you stand to earn from dividends, interest payments, capital gains, and any other forms of compensation will most likely dwarf the amount you stand to earn or save from a wildly inconsistent investment strategy.
Assuming you own 100 shares of a stock that has a yearly dividend of $4, that’s $400 every year, and will only grow over time if you reinvest those earnings. Unless a market timing strategy can surpass this relatively low benchmark year after year, then it probably isn’t worth considering in the first place.
Now, having a long investment career doesn’t mean success is inevitable, but assuming you constantly work on yourself and do your best to make prudent investment decisions, then you greatly increase your chances.
Wrapping Up
“Buy low, sell high” is an oft-repeated saying when it comes to describing how individuals should hope to earn money from financial markets. Though this sounds simple enough, this assumes that an investor knows when precisely to time their purchases and sales, that is, they’re experts in market timing.
Given its highly unpredictable nature and inconsistent results, it’s very hard to endorse market timing as a valid investment strategy. Many smart people have devised all sorts of formulas and models to try and predict what markets will do next, but no matter how complex these tools become none of them can infallibly predict what future prices of investment instruments will be.
Because of this, investors are usually better off trying to spend as much time in markets as possible. The gains they stand to gain from correctly timing the market every once in a while will pale in comparison to the dividends, interest payments, capital appreciation, and capital gains they stand to potentially earn, assuming they consistently make prudent investment decisions and constantly improve themselves.
