Timing the market and time in the market are two popular concepts in the financial market. On a semantic level they seem like two very similar things...well, they're not. One technique is the exact opposite of the other!
In this article, we will look at what they are, the risks involved, and some of the top strategies to help improve your profitability.
What is timing the market?
Timing the market is the process of identifying the best entry points for an asset. A good way to look at market timing is what sports experts do. Every day before a match starts, sports experts usually come up with odds on the teams that will win and those they expect to lose.
To do that, they look at the overall form of the teams and their past performance. In some cases, the experts’ predictions will be right, while in other cases, the experts will be wrong. In other words, they have timed the market.
The same happens in the financial market, where analysts attempt to identify the best entry points of an asset.
For example, if a stock suddenly falls from $20 to $18 within a session, some analysts and traders will start identifying the best entry points. Some of them will buy the stock hoping that it will bounce back later. Others will short the stock hoping that it will continue the downward trend.
» Related: Why The Time of the Day Matter
Timing the market is a relatively controversial activity that many veteran money managers have warned against. Most of those who don’t believe in timing the market are long-term investors like Warren Buffett and David Einhorn.
Still, many day traders believe strongly in the concept of timing the market. They use several approaches to identify entry and exit points. Most of these traders use the concepts of technical analysis and price action strategies to identify when to buy or short an asset. You can read our comprehensive guide on market timing here.
What is time in the market?
The opposite of timing the market is known as time in the market. The idea simply argues that people who buy assets and hold them for a long time will often be more successful than market timers.
It says that patience and time in the market will make you relatively successful. This will happen because stocks tend to rise over time. As they rise, you will benefit from this and also their dividends.
Dollar-cost averaging (DCA)
One strategy of making money through time in the market is known as dollar-cost averaging (DCA). It involves buying a certain stock or asset over an extended period.
For example, if you have $10,000, you could divide the funds into five. This means that you could buy stocks several times instead of 1. In this case, if the stock is trading at $10, you could start by buying 200 shares. You should then buy more shares if it keeps dropping.
While DCA is a strategy that works, there are several risks involved. First, there is the risk that emerges when the stock keeps dropping over time. This means that you will keep buying more shares of a stock that will not bounce back.
Another risk is that the stock will keep rising over time. As such, if you buy a stock at $10, it could keep rising such that you will pay more money to acquire it.
Timing the market vs time in the market
As mentioned above, there is currently an ongoing debate about which is better between timing the market and time in the market. At DTTW™, we believe that people should embrace the two approaches. In this, they should allocate their capital in both short-term and long-term accounts.
We also believe that there are risks of both timing the market and holding an asset for an extended period of time.
Risks of Time in the Market
As mentioned, there are risks involved in dollar-cost averaging, which is a popular approach of time in the market. Other risks involved when you hold trades for so long are:
- Macro events - There are several macro events that could drag stocks and other assets lower. Examples of these are interest rates and a sudden change in economic data.
- Pandemic - A global pandemic (or other exceptional events) could have a major impact on assets. A good example is what happened when stocks crashed after the World Health Organization (WHO) made Covid a global pandemic.
- Politics - A sudden change in political leadership could have an impact on stocks and other assets.
- Demographic shifts - At times, a change in demographics could have a major impact on stocks.
- Regulations - A change in regulations could have a negative impact on stocks. For example, regulations on oil and gas companies could affect their performance.
Risks of Timing the Market
There are also risks with timing the market. These include:
- Stock picking is tough - A key risk in the market is that stock picking is a relatively tough activity. Selecting stocks whose prices will rise is a bit tough.
- Tough to identify bottoms and tops - Another risk of timing the market is that identifying tops and bottoms is relatively tough. At times, the conventional strategies used such as technical analysis don’t work.
- Active management - Timing the market requires active management, where you spend a considerable amount of time trading. This might be a difficult thing for most employed people.
Summary: Which is better?
So, which is better between timing the market and time in the market? The answer is a hybrid model that involves the two. You should allocate some money into an account that generates returns and others in an account that you actively manage.
» Related: The Power of Stock Diversification
External useful resources
- Does Market Timing Work? - Schwab
- Is Market Timing Everything, or Does Patience Pay Off? - Nerdwallet
