Tuesday, September 28, 2010

Why Timing the Market is a Bad Idea

Over the weekend, The Wall Street Journal's James B. Stewart wrote an article entitled, "How to Time the Stock Market". Naturally, I'm skeptical of any system that pledges to consistently "outperform a simple buy-and-hold index approach" as the article states. With that said, Stewart goes through a system which he describes as follows:

"Here is how the system works: When the market is dropping, I buy stocks at intervals of 10% declines from the most recent peak. When it is rising, I sell at intervals of 25% gains from the most recent low. These figures are roughly one-half the historical average losses of 20% in bear markets and gains of 50% in bull markets since 1979. They are round numbers and the math is easy to do in your head."

Here's the problem: there's an emotional aspect to this "system" that will ruin most investors who engage in it. Not all people will be as disciplined as Mr. Stewart is in implementing his system and the result will be severe underperformance for investors who do not have the discipline to stick to the system and instead incur high fees and trading costs which eat profits.

Worse still, if any of your stocks have rapid movements and you're forced to buy/sell often, you'll incur short-term capital gains taxes, which, depending on your tax bracket, can be as high as 35%! This will quickly destroy any of the value such a market timing system would have for you. Lastly, who has the patience to market time? It's unlikely that Gen Y wants to be bothered with setting up models to help them determine which stocks are rising and falling from valleys and peaks. More importantly, we have bigger obligations like school and work to deal with. With that said, it's best just to buy the entire market via an indexing strategy that's low-cost and won't keep you up at night.


  1. Some computer programmer with a lot of time on their hands may make a killing on this strategy, but those of us without robotic companions performing the trades for us and without the free time to sit in front of our computers paying attention all day making swift, calculated trades with no overriding passion to push our luck...you're right. How's this guy even do it?

  2. I'm really wondering that myself! He has an interesting strategy for himself, but there's no way you or I would have the patience or interest to pursue that.

    I guess it's also feasible you could do this type of trading on a fixed fee schedule with a broker, but that still overlooks potential short-term taxable gains implications. I never understood why anyone would want to go through all of the trouble when the odds of success are so low.