market timing

Market timing can cause poor performance.{{cite journal |last1=Metcalfe |first1=Guy |title=The mathematics of market timing |journal=PLOS ONE |date=18 July 2018 |volume=13 |issue=7 |pages=e0200561 |doi=10.1371/journal.pone.0200561 |pmid=30021021 |pmc=6051602 |arxiv=1712.05031 |bibcode=2018PLoSO..1300561M |doi-access=free }}

After fees, the average "trend follower" does not show skills or abilities compared to benchmarks. "Trend Tracker" reported returns are distorted by survivor bias, selection bias, and fill bias.[http://depot.som.yale.edu/icf/papers/fileuploads/2429/original/08-21.pdf] Yale ICF Fooling Some of the People All of the Time: The Inefficient Performance and Persistence of Commodity Trading Advisors | Working Paper No. 08-21 October 2008 | Geetesh Bhardwaj AIG Financial Products; Rutgers University - Department of Economics Gary B. Gorton Yale School of Management; National Bureau of Economic Research (NBER) K. Geert Rouwenhorst Yale School of Management, International Center for Finance

At the Federal Reserve Bank of St. Louis, YiLi Chien, Senior Economist wrote about return-chasing behavior. The average equity mutual fund investor tends to buy mutual funds with high past returns and sell otherwise. Buying mutual funds with high returns is called a “return-chasing behavior.” Equity mutual fund flows have a positive correlation with past performance, with a return-flow correlation coefficient of 0.49. Stock market returns are almost unpredictable in the short term. Stock market returns tend to go back to the long-term average. The tendency to buy mutual funds with high returns and sell those with low returns can reduce profit.{{cite web|title=Chasing Returns Has a High Cost for Investors | St. Louis Fed On the Economy|url=http://www.stlouisfed.org/on-the-economy/chasing-returns-has-a-high-cost-for-investors/|access-date=2015-02-03|archive-date=2014-12-27|archive-url=https://web.archive.org/web/20141227015312/http://www.stlouisfed.org/on-the-economy/chasing-returns-has-a-high-cost-for-investors/|url-status=dead}}

Institutional investors often use proprietary market-timing software developed internally that can be a trade secret. Some algorithms attempt to predict the future superiority of stocks versus bonds (or vice versa),{{cite journal|last1=Merton|first1=Robert C.|date=1981|title=On Market Timing and Investment Performance. I. An Equilibrium Theory of Value for Market Forecasts|journal=The Journal of Business|volume=54|issue=3|pages=363–406|doi=10.1086/296137|jstor=2352345}}{{cite journal|last1=Henriksson|first1=Roy D.|last2=Merton|first2=Robert C.|date=1981|title=On Market Timing and Investment Performance. II. Statistical Procedures for Evaluating Forecasting Skills|journal=The Journal of Business|volume=54|issue=4|pages=513–533|doi=10.1086/296144|jstor=2352722}} have been published in peer-reviewed journals.

Market timing often looks at moving averages such as 50- and 200-day moving averages (which are particularly popular).{{cite web|last=staff|first=CNBC.com|date=13 October 2014|title=The technical indicator that made the market tank|website=CNBC |url=https://www.cnbc.com/2014/10/13/cnbc-explains-the-200-period-moving-average.html}} Some people believe that if the market has gone above the 50- or 200-day average that should be considered bullish, or below conversely bearish.{{cite web|last=Hulbert|first=Mark|title=Good enough|url=http://www.marketwatch.com/story/using-the-200-day-moving-average-2010-03-17}} Technical analysts consider it significant when one moving average crosses over another. The market timers then predict that the trend will, more likely than not, continue in the future. Others say, "nobody knows" and that world economies and stock markets are of such complexity that market-timing strategies are unlikely to be more profitable than buy-and-hold strategies.

Moving average strategies are simple to understand, and often claim to give good returns, but the results may be confused by hindsight and data mining.{{cite journal|last1=Zakamulin|first1=Valeriy|date=August 2014|title=The real-life performance of market timing with moving average and time-series momentum rules|journal=Journal of Asset Management|volume=15|issue=4|pages=261–278|doi=10.1057/jam.2014.25|s2cid=195333197}}{{cite SSRN|last1=Zakamulin|first1=Valeriy|date=11 December 2015|title=A Comprehensive Look at the Empirical Performance of Moving Average Trading Strategies|ssrn=2677212}}

A major stumbling block for many market timers is a phenomenon called "curve fitting", which states that a given set of trading rules tends to be over-optimized to fit the particular dataset for which it has been back-tested. Unfortunately, if the trading rules are over-optimized they often fail to work on future data. Market timers attempt to avoid these problems by looking for clusters of parameter values that work wellPruitt, George, & Hill, John R. Building Winning Trading Systems with TradeStation(TM), Hoboken, N.J: John Wiley & Sons, Inc. {{ISBN|0-471-21569-4}}, p. 106-108. or by using out-of-sample data, which ostensibly allows the market timer to see how the system works on unforeseen data. Critics, however, argue that once the strategy has been revised to reflect such data it is no longer "out-of-sample".

Mutual fund flows are published by organizations like Investment Company Institute, Lipper, Morningstar, and TrimTabs.{{Cite web|title = Estimated Long-Term Mutual Fund Flows - Data via Quandl|url = https://www.quandl.com/data/ICI1|website = www.quandl.com|access-date = 2015-10-01}} They show that flows generally track the overall level of the market: investors buy stocks when prices are high, and sell stocks when prices are low. For example, in the beginning of the 2000s, the largest inflows to stock mutual funds were in early 2000 while the largest outflows were in mid-2002. These mutual fund flows were near the start of a significant bear (downtrending) market and bull (uptrending) market respectively. A similar pattern is repeated near the end of the decade.{{cite web|last=Kinnel|first=Russel|date=15 February 2010|title=Bad Timing Eats Away at Investor Returns|url=http://news.morningstar.com/articlenet/article.aspx?id=325664|url-status=dead|archive-url=https://web.archive.org/web/20170926235615/http://news.morningstar.com/articlenet/article.aspx?id=325664|archive-date=26 September 2017|website=Morningstar.com}}[http://www.ici.org/new/ww_12_08.html Worldwide Mutual Fund Assets and Flows, Fourth Quarter 2008]{{dead link|date=June 2017 |bot=InternetArchiveBot |fix-attempted=yes }}[https://finance.yahoo.com/banking-budgeting/article/110866/you-should-have-timed-the-market You Should Have Timed the Market] {{Webarchive|url=https://web.archive.org/web/20101011035203/http://finance.yahoo.com/banking-budgeting/article/110866/you-should-have-timed-the-market |date=2010-10-11 }} on finance.yahoo.com{{cite web|url=https://www.washingtonpost.com/wp-dyn/content/article/2008/12/25/AR2008122500759.html|title=Investors Flee Stock Funds|first=Michael S. Rosenwald and Heather|last=Landy|date=26 December 2008|via=www.washingtonpost.com}}{{cite web|url=http://www.businessinsider.com/blackrock-sp-500-vs-equity-fund-flow-2013-4|title=CHART: Investors Buy And Sell Stocks At Exactly The Wrong Times|website=Business Insider }}

This mutual fund flow data seems to indicate that most investors (despite what they may say) actually follow a buy-high, sell-low strategy.{{cite web|url=https://finance.yahoo.com/retirement/article/107116/If-You-Think-Worst-Is-Over-Take-Benjamin-Graham's-Advice?mod=retire-planning|title=If You Think Worst Is Over, Take Benjamin Graham's Advice|access-date=2017-01-17|archive-url=https://web.archive.org/web/20090530222103/http://finance.yahoo.com/retirement/article/107116/If-You-Think-Worst-Is-Over-Take-Benjamin-Graham's-Advice?mod=retire-planning|archive-date=2009-05-30|url-status=dead}}{{cite web|url=https://www2.blackrock.com/us/financial-professionals/market-insight/chart-of-the-week/since-when-did-it-become-buy-high-sell-low|title=Since When Did It Become Buy High, Sell Low?: Chart of the Week: Market Insight: Financial Professionals: BlackRock|access-date=2014-01-14|archive-url=https://web.archive.org/web/20140114225104/https://www2.blackrock.com/us/financial-professionals/market-insight/chart-of-the-week/since-when-did-it-become-buy-high-sell-low|archive-date=2014-01-14|url-status=dead}} Studies confirm that the general tendency of investors is to buy after a stock or mutual fund price has increased.{{cite journal |last1=Frazzini |first1=Andrea |last2=Lamont |first2=Owen A. |title=Dumb money: Mutual fund flows and the cross-section of stock returns |journal=Journal of Financial Economics |date=May 2008 |volume=88 |issue=2 |pages=299–322 |doi=10.1016/j.jfineco.2007.07.001 |s2cid=16090053 |url=http://www.nber.org/papers/w11526.pdf }} This surge in the number of buyers may then drive the price even higher. However, eventually, the supply of buyers becomes exhausted, and the demand for the stock declines and the stock or fund price also declines. After inflows, there may be a short-term boost in return, but the significant result is that the return over a longer time is disappointing.

Researchers suggest that, after periods of higher returns, individual investors will sell their value stocks and buy growth stocks. Frazzini and Lamont find that, in general, growth stocks have a lower return, but growth stocks with high inflows have a much worse return.

Studies find that the average investor's return in stocks is much less than the amount that would have been obtained by simply holding an index fund consisting of all stocks contained in the S&P 500 index.{{cite web|url=https://www.forbes.com/sites/tomanderson/2013/03/28/fund-investors-lag-as-sp-500-nears-all-time/|title=Fund Investors Lag As S&P 500 Nears All-Time High|first=Tom|last=Anderson|website=Forbes }}{{cite web|url=http://corporate.morningstar.com/US/documents/MethodologyDocuments/FactSheets/InvestorReturns.pdf|title=Fact Sheet: Morningstar Investor Return|archive-date=2007-01-26|archive-url=https://web.archive.org/web/20070126181402/http://corporate.morningstar.com/us/documents/PR/Investorreturnsfactsheet.pdf|url-status=dead}}{{cite web|url=http://seekingalpha.com/article/64111-black-swans-portfolio-theory-and-market-timing|title=Black Swans, Portfolio Theory and Market Timing|date=11 February 2008 }}{{cite web|url=http://www.marketwatch.com/story/mutual-funds-are-smarter-than-you-2014-03-04|title=Mutual funds far outperform mutual fund investors|website=MarketWatch}}{{cite web|url=http://www.beyondproxy.com/market-timing-usually-leads-lower-returns/|title=Market Timing Usually Leads to Lower Returns - BeyondProxy|publisher=Beyond Proxy|access-date=2014-06-25|archive-url=https://web.archive.org/web/20180209114331/http://www.beyondproxy.com/market-timing-usually-leads-lower-returns/|archive-date=2018-02-09|url-status=dead}}

For the 20-year period to the end of 2008, the inflation-adjusted market return was about 5.3% on average per year. The average investor managed to turn $1 million into $800,000, against $2.7 million for the index (after fund costs).{{cite web|url=http://www.masecoprivatewealth.com/iq/issue14/swiss/insight.php|title=Commodities - Issue 14 - Investment Newsletter - MASECO Private Wealth|website=www.masecoprivatewealth.com|access-date=2014-06-26|archive-date=2016-03-04|archive-url=https://web.archive.org/web/20160304031912/http://www.masecoprivatewealth.com/iq/issue14/swiss/insight.php|url-status=dead}}

Studies by the financial services market research company Dalbar say that the retention rate for bond and stock funds is three years. This means that in a 20-year period the investor changed funds seven times. Balanced funds are a bit better at four years, or five times. Some trading is necessary since not only is the investor return less than the best asset class, it is typically worse than the worst asset class, which would be better.{{cite web|url=http://www.businessinsider.com/chart-proof-that-you-stink-at-investing-2013-3|title=CHART: Proof That You Stink At Investing|website=Business Insider}} Balanced funds may be better by reason of investor psychology.{{cite news |last1=Richards |first1=Carl |title=Forget Market Timing, and Stick to a Balanced Fund |url=https://www.nytimes.com/2014/01/28/your-money/forget-market-timing-and-stick-to-a-balanced-fund.html |work=The New York Times |date=27 January 2014 }}

Financial advisors often agree that investors have poor timing, becoming less risk averse when markets are high and more risk averse when markets are low, a strategy that will actually result in less wealth in the long-term compared to someone who consistently invests over a long period regardless of market trends.{{cite news |last1=Lieber |first1=Ron |title=Switching to Cash May Feel Safe, but Risks Remain |url=https://www.nytimes.com/2008/10/09/business/yourmoney/09money.html |work=The New York Times |date=8 October 2008 }}{{cite web|url=http://www.fibtimer.com/subscribers_historical_reports/040912_fibtimer_commentary.asp|title=Emotions And Market Timing, Emotions and Timing|website=www.fibtimer.com}} This is consistent with recency bias and seems contrary to the acrophobia explanation. Similarly, Peter Lynch has stated that "Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in the corrections themselves."As quoted in "[http://davisadvisors.com/davissma/downloads/WGI.pdf The Wisdom of Great Investors: Insights from Some of History’s Greatest Investment Minds], by Davis Advisers, p. 7

Proponents of the efficient-market hypothesis (EMH) claim that prices reflect all available information. EMH assumes that investors are highly intelligent and perfectly rational. However, others dispute this assumption.Jim Cramer's Getting Back to Even, pp. 63-64 In particular, proponents of behavioral finance claim that investors are irrational but their biases are consistent and predictable.

Whether market timing is ever a viable investment strategy is controversial. Some may consider market timing to be a form of gambling based on pure chance, because they do not believe in undervalued or overvalued markets. The efficient-market hypothesis claims that financial prices always exhibit random walk behavior and thus cannot be predicted with consistency.

Some consider market timing to be sensible in certain situations, such as an apparent bubble. However, because the economy is a complex system that contains many factors, even at times of significant market optimism or pessimism, it remains difficult, if not impossible, to predetermine the local maximum or minimum of future prices with any precision; a so-called bubble can last for many years before prices collapse. Likewise, a crash can persist for extended periods; stocks that appear to be "cheap" at a glance, can often become much cheaper afterwards, before then either rebounding at some time in the future or heading toward bankruptcy.

Proponents of market timing counter that market timing is just another name for trading. They argue that "attempting to predict future market price movements" is what all traders do, regardless of whether they trade individual stocks or collections of stocks, aka, mutual funds. Thus if market timing is not a viable investment strategy, the proponents say, then neither is any of the trading on the various stock exchanges. Those who disagree with this view usually advocate a buy-and-hold strategy with periodic "re-balancing".{{fact|date=September 2020}}

Others contend that predicting the next event that will affect the economy and stock prices is notoriously difficult. For examples, consider the many unforeseeable, unpredictable, uncertain events between 1985 and 2013 that are shown in Figures 1 to 6 [pages 37 to 42] of Measuring Economic Policy Uncertainty.{{cite journal |last1=Baker |first1=Scott R. |last2=Bloom |first2=Nicholas |last3=Davis |first3=Steven J. |title=Measuring Economic Policy Uncertainty* |journal=The Quarterly Journal of Economics |date=1 November 2016 |volume=131 |issue=4 |pages=1593–1636 |doi=10.1093/qje/qjw024 |doi-access=free }}

A 2004 study suggested that the best predictor of a fund's consistent outperformance of the market was low expenses and low turnover, not pursuit of a value or contrarian strategy.{{cite journal |last1=Malkiel |first1=Burton G. |title=Can Predictable Patterns in Market Returns be Exploited Using Real Money? |journal=The Journal of Portfolio Management |date=31 January 2004 |volume=30 |issue=5 |pages=131–141 |doi=10.3905/jpm.2004.442638 |s2cid=154981913 }}

Several independent organizations (e.g., Timer Digest and Hulbert Financial Digest) have tracked some market timers' performance for over thirty years. These organizations have found that purported market timers in many cases do no better than chance, or even worse.

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• {{annotated link|Stock market prediction}}
• {{annotated link|Sector rotation}}
• {{annotated link|Style investing}}
• {{annotated link|Stock market cycles}}
• {{annotated link|Market trend}}
• {{annotated link|Asset allocation}}
• {{annotated link|Great Recession in the United States}}
• {{annotated link|Dynamic factor}} In econometrics, a dynamic factor (also known as a diffusion index) were originally designed to help identify business cycle turning points.

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{{Reflist}}

• [http://www.kansascityfed.org/Publicat/Reswkpap/PDF/RWP02-01.pdf Market-Timing Strategies that Worked] {{Webarchive|url=https://web.archive.org/web/20190507051202/https://kansascityfed.org/publicat/reswkpap/PDF/RWP02-01.pdf |date=2019-05-07 }}
• [https://www.quandl.com/data/ICI1 Quandl Data on Estimated Long-Term Mutual Fund Flows]

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Category:Investment