Market Timing

April 6th, 2008 by Potato

Michael James on Money has written a few good pieces on market timing lately. Trying to time the market is always a fairly risky affair, though it sounds so very lucrative. Basically, there’s a lot of variability in the market, and it goes down a lot, as seen recently. If you could just avoid those downturns (sell your stocks, jump to cash), you could do so much better. The trick is that it’s essentially impossible to predict market downturns in the near term. Since the market tends to go up over time, guessing wrong and jumping out of the market too early makes you sit on the sidelines while your stocks go up and you end up doing worse than someone who just bought and held. Plus, as an in-and-out market timer, you have to guess right twice: first, when to get out, and second, when to get back in. Being wrong on either one can hurt your returns. Michael James ran a number of simulations to show that it’s better to be a buy and hold investor than a market timer, assuming that you can’t actually see into the future.

I had one more variation on the market timing strategy that I wanted to test out, because it’s one that I’ve been using myself lately without really thinking about it. The strategy is basically to be a buy and hold investor, but to time my market entry as money is saved every month. Essentially, to wait until a drop in the market to buy in. For me, it’s worked out fairly well in this market the last few months because, well, recently the market has been insane with big swings in both directions, so it hasn’t been hard at all to wait for a day when everything is down over a percent or two. I thought that this strategy might work because for one thing, you only need to guess right once (when to buy), and for another, it might be a way to take advantage of some of the short-term noise in the market (it goes up and down daily, so you don’t spend very long at all waiting for a down day, whereas with other market timing strategies you might wait a long time for a significant downward movement, or a downward month, and spend too much time on the sidelines). The premise is that you are saving regularly, and have some amount available; $500 on the first of each month in this example. Then, you just pick your moment on when to invest it in the market. Michael James was kind enough to run this scenario for me on his data, and found that investing immediately when the money was available was better than trying to time the market, but this strategy was at least not terrible like some other market timing strategies can be, but it’s still not great. I still harboured hopes/suspicions that with more noise in the data, more variability to take advantage of, that this strategy could be a winner (his data only sampled the market monthly).

To test this, I needed daily historical stock market data, which I found somewhat difficult to come by. I ended up using the NAV chart from ishares which gave me daily data for their S&P TSX composite index from 2001 on. This, I think, should be a very good surrogate for actual daily data from the TSX. While it would have been nice if I had made some nice elegant program in Matlab or something, instead I just bashed together a mess in Excel, which you can download here.

My results? Well, if you wait for any daily change of less than zero (any down day), you do slightly worse from March ’01 to March ’08 (the timer would own ~751 shares of the index fund, vs ~757 for the investor who immediately bought in each month). If you wait for a bigger down day (a negative movement of at least a percent), you do even worse (~749 shares). As one might expect, in “bear” markets, holding off a bit was a better strategy than buying immediately, but overall this was not a good strategy (and bull markets tend to be the norm) — plus there’s a good chance that this result is due to chance alone!

Buy (immediately) & hold it is!

[Oh, and for the curious: saving $500/mo over those 7 years (+2 mo) comes out to $43000 packed away. The “index” here is worth $84.70 at the end, so 757 shares comes out to $64117.90; missing out on ~6 shares from trying to time the market is about $500 you’d be out — just about one month’s worth of savings!]

Comments are closed.