Market timing
In early 2009, millions of would-be investors were reluctant to move into equities because the Stock market was falling too fast. Now many are wary because the market is rising too fast.
In retrospect, of course, it would have been better to get out of the equity market completely in October 2007 and move into cash and government bonds, before reversing course again in early March 2009. The reality is that correctly timing your exit and entry to the market to this extent is impossible – yet investors suffer from a hindsight bias – past events after the fact now seem obvious, leading us to believe that our ability to predict future events is greater than it really is.
Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets, is a book written by Nassim Nicholas Taleb about the fallibility of human knowledge. Taleb sets forth the idea that modern humans are often unaware of the very existence of randomness. They tend to explain random outcomes as non-random and perhaps this explains the tendency of investors to study charts of historic prices in an attempt to guess the future movement of securities.
The real problem with attempting to time markets is the lack of any form of reliable signal upon which to base the buy and sell decisions. It is often said that “they don’t ring a bell to tell you that it is the bottom of the market”.
To make matters worse, the media assails investors with a constant stream of analysis and comment and many investors subscribe to market updates in an attempt to beat the market. However, studies consistently show that these services add no value to investors. "We find no evidence that (these updates) systematically increase equity weights before market rises or decrease weights before market declines." In a study of 15,000 predictions over 12 years from 237 Market Timers, there was no evidence of market timing skill.
Any market timing strategy requires three correct guesses; when to get in, when to get out and when to get back in again.
"Gains from market timing over the long run require forecast accuracies that are likely to be beyond the reach of most managers. More frequent forecasting increases the potential return available and reduces the level of accuracy required to outperform the market, but the transaction costs incurred in more frequent switching reduce the advantage."
In an investigation into whether mutual funds exhibited market timing ability "The empirical results do not support the hypothesis that mutual fund managers are able to follow an investment strategy that successfully times the return on the market portfolio."
If highly paid, highly educated, highly experienced mutual fund managers can't successfully time the market with the assistance of large support staffs of brilliant analysts, it seems imprudent to think that any particular layperson can expect do so.
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