Last Updated on February 12, 2022 at 6:25 pm
Are you interested in timing the market? Then here is how you can do it right. Please do not assume that buying on dips is market timing. It is delusional. In June 2018 I started a market timing aka tactical asset allocation series, and I was surprised by the reactions to it. Most people who wanted to time the market were unwilling to sell existing equity or fixed income investments as per market conditions! This is like wanting to play the piano without touching a key or wanting to swim without getting wet.
In this post, I link to earlier studies on what works and what does not in market timing. There are tens of timing models and I have backtested a few with more to go. The essential message in this post is:
market timing = tactical asset allocation
market timing <> dip buying
1 What is timing the market?
The equity allocation in your portfolio is decided by market conditions, determined either using technical indicators such as these: Are we now in a bear market? Market Analysis (October 2018) or macroeconomic indicators such as this: Term spread as a macroeconomic indicator
2 Why time the market?
For lowering portfolio risk and NOT for getting higher returns. Those who want higher returns by timing have never bothered to study back-tests such as the ones linked here: Is it possible to time the market?
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3 Is it possible to time the market? Or Can we time the market?
Of course, it is! Do not listen to “advisors” they are worried about losing commissions if you change equity allocation. Want proof? Read on.
4 Should you time the market?
That depends on your investment strategy. I have shown that for those with a clear asset allocation plan, and how to changes it year on year as the time for the goal nears, there is NO need to time the market
5 What do investors want?
As usual nothing realistic! They want to time the market but are worried about tax and exit load. They are unwilling to sell equity when the market is high and re-buy when the market is low. That is just too much work. They want the reward without effort. Very practical indeed!
A few days ago I conducted a poll in FB group, Asan Ideas for Wealth with the following four options for investors who wanted to time the market
- I time the market ONLY by buying MORE when the market falls: 107 votes
- I am interested in timing ONLY by buying MORE when the market falls: 57 votes
- I time the market by selling equity holding when the market is high and re-buying when the market is low: 12 votes
- I am interested in timing by selling equity holding when the market is high and re-buying when the market is low: 73 votes
Notice the disparity between choices 1 and 3. So essential only 12 people who participated in the poll are timing the market and 73 want to do so. The 107 (57) who voted for option 1 (2) need to recognise that “dip buying” even with the help of indicators and not random opinions is not market timing.
That is, the effect of “dip buying” on portfolio returns is not significant enough considering the effort and taxes involved.
6 Proof that dip buying does not work
Over the years I have shown again and again that simply buying on market lows does little to help with returns or risk. What investors simply fail to understand is, that main risk stems from the corpus already in the market and not from when you invest the next time! For example, suppose you have been investing Rs. One thousand a month for say five years and the amount has grown close to one lakh. That one lakh is in the market at all times and can anytime drop in value by 40%. How will it matter if you wait for the right market PE or daily moving average to invest the next few thousands?
Here are the earlier posts
- Buying on market dips: How effective is it?
- Nifty 200 DMA: Buying High vs Buying Low
- Equity: Buying High vs Buying Low
- Buying low vs Buying systematically: Surprise, Surprise!
- Buying low with active cash vs buying systematically: still a surprise!
- Should I book profit when the market is at an all-time high?
7 Market timing or tactical asset allocation methods (and proof that it works!)
There are dozens of methods and I have only backtested a few.
Index PE: Market Timing with Index PE Ratio: Tactical Asset Allocation Backtest Part 1
Ten-month moving average (same as a 200-day moving average): Market Timing With Ten Month Moving Average: Tactical Asset Allocation Backtest Part 2
Tactical Asset Allocation Backtest Part 3: Short-Term Vs Long-Term
Index PE, PB Dividend Yield Combo: Market Timing with the Motilal Oswal Value Index (MOVI)
Double moving average crossovers: Timing the market by spotting bullish and bearish trends
Other methods that I am aware of include momentum, a combination of long term technical indicators. See: Spotting Market “highs” and “lows” Using Technical Indicators, derivatives (not the investment!), volatility based timing. There should be more.
My dream is to use Fractal math to model market noise for timing. See:
- Five Books That Will Redefine Your Understanding of Stock Markets and
- The 80/20 rule: Making sense of richest 1% Indians owning 58% wealth! and
- Fractals: The True Nature of Stock Market Returns – Part 2
8 How to time the market?
- Ignore all noise, opinion and speculation about the market
- Use only hard data: Either long term technical indicators (based on math, not arbitrary lines) and/or macroeconomic indicators
- Choose a method from the above or elsewhere.
- Use back-testing to find out how often you will need to buy and sell.
- Adjust the frequency of monitoring to minimise buy and sell
- Understand the impact of actions on returns and risk using the back-test
- Execute and shut yourself out from all other information sources. Otherwise, timing will not work.
9 Emotions cannot be backtested!
This is a common criticism of those who oppose market timing (most of whom are advisors with a conflict of interest). The problem is that most people do not understand the difference between, can we time the market? and do we need to time the market?
Yes, most people have trouble keeping emotions away from investing and are prone to mistake. Hey, that just proves that they are human. Most people can’t climb Everest. Even among those who try, many fail. So does that mean we tell future generations that there is no such thing as Everest so that no one tries and no one fails?
It is human nature to try and model the stock market no matter how hard it is. The only problem is that it has to be executed with the right expectations. Emotions are not as big a problem as laziness is Most people assume what “appears” like common sense to them (e.g. dip buying) must be true and hold on to it like faith without ever finding out if it works or not!
When we dig deep enough, what will work, and what will not, becomes clear sooner or later. Then it is simply a matter of choosing. Well, simple, but not easy!
So what should I do?
If you want to time the market, do it for reducing risk and not enhancing returns. Do it selling when the market is up and re-buying when low. Recognise that dip buying is a childish pursuit without commensurate reward. If all this confuses you, do not worry about timing. Merely decide on equity: fixed income allocation and decrease it in a stepwise manner regardless of returns and regardless of how close you are to your goals. Use the Freefincal Robo Advisory Software Template to automated this strategy for you and focus on your hobbies!
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