by Tyler Curtis
For as long as markets have been around there has been a subset of participants that believe they can outsmart the market. These investors are frequent traders that believe they can consistently time the market to buy low and sell high. Over the years investors have developed many techniques from the fundamental analysis of companies’ financial statements to drawing lines across charts of a stock’s historical price movement. Do these techniques work in the long term? The data suggest they do not.
The market research firm DALBAR looked at returns for mutual fund investors from 1986-2006 and found the average market timer return was -2%. During that same period the S&P 500 Index return was 12%.
What is responsible for the considerable gap in performance? Market timers tend to fall victim to several pitfalls that investors following other styles tend to avoid.
Identifying peaks and bottoms is extremely tricky. Markets are driven by thousands of variables and it is difficult to assess which variable is going to have the most immediate effect on the market’s direction. This makes identifying the market’s highs and lows near impossible causing market timers who don’t pick their entry points properly to face large losses.
Missing high-return days, missing just a handful of the market’s best days in a given time period can be detrimental to long term returns. For example if an investor sat out on the 50 best days in the market from 1974-2007 his average annual total return would have been just 7.8% compared to 13.4% for investors who remained fully invested.
Increased Volatility, with the uncertainty across Europe and the large short term moves we have seen since the financial crises one-day market swings of more than 1-2% are not uncommon. A recent analysis of daily price movements by The New York Times suggest that the increased speed of trading and information over the last decade has also increased the markets daily volatility. This can be bad news for market timers who find themselves on the wrong side of a large daily move.
Letting emotions drive their investing decisions. Fear, greed, and impatience can be the enemy of any investor, but they can especially wreak havoc on market timers. The emotional side effects of making poorly timed investments can consequently cause a market timer to make perilous investment decisions in the hopes of making up losses.
Market timing sounds appealing and the short term rewards can be quite substantial, but the statistics say it is very difficult to do so consistently. The market moves extremely fast nowadays, when you hear the latest news come across the wire remember that you are far from the first to hear it and other investors have most likely already acted on it. The best way to safeguard yourself from making these common investing mistakes is to find disciplined investment game plan that does not attempt to time the market.