Timing the Stock Market
- Investors who attempt to beat the market want to take advantage of the fact that at times the market can move up and down very quickly. Studies have shown that the majority of returns on stock investments occur during a small window of time. The majority of time stocks trade in a relatively narrow range. Market timers try to find this window of market opportunity.
- Market timers look to create a system to help them predict when these major upward and downward moves are likely to occur. They watch economic indicators that give them clear -- they hope -- buy or sell signals. Interest rates are one popular indicator used. When the Federal Reserve raises interest rates, especially when it makes a series of rate increases, it can have a negative effect on stock prices. Conversely, an environment of lower rates has historically been positive for stock prices. Another widely used method is called advance-decline theory, which tracks the number of stocks going up in value compared to the number declining. The running total is depicted in chart form in what is termed the advance-decline line. The theory's proponents say the chart can indicate when the market is about to change direction.
- The very reason market timers use to justify their strategy can often be their undoing. Since upward moves in a stock can be dramatic at times, not being invested in the market when these moves occur causes the investor to miss out on the opportunity. And market timing implies that there are times you will not be invested in the market. The patient investors who don't move in and out of the market frequently are more likely to be able to participate in these dramatic upward moves. The fact is that even for highly knowledgeable or experienced investors, accurately predicting major moves of the stock market is extremely difficult.
- Asset allocation is a system of investing based on the idea that returns can be higher and investment risk lower if you diversify your investments across several classes of assets -- stocks, bonds and real estate -- as well as having a portion in safer investments such as savings accounts and certificates of deposit. At times when the stock market is declining, you will still be earning returns from the other asset classes you have chosen. This method allows you to employ a more patient buy-and-hold strategy rather than frequently jumping in and out of the stock market.
- Frequent buying and selling of stocks results in higher transaction costs -- the costs of making stock trades -- than pursuing a buy-and-hold strategy. The market-timing strategy can result in a higher tax bill as well. Shares held longer than one year are taxed at the lower long-term capital gains rate. The tax rates for short-term gains on shares held for less than one year are significantly higher.