What’s wrong with market timing?

clockHave you ever heard that the best comics have great timing? I’m not one of them. My timing is awful. I zig when I should zag, I go left when I should have gone right, and I couldn’t tell you how many times I bought a stock when I should have sold. Yet, as a musician for a living (yes, I actually make money doing it) my timing is what pays my bills.

I’m convinced that there are more people with bad timing than there are good timing but that isn’t the timing we’re talking about today. Have you ever heard of market timing? If you are interested in the stock market, you know all too well about it. My disclosure is this: I’m as guilty as the next guy. I put a small amount of my investment money towards market timing so although I may sound anti-market timing, the truth is that I’m one of them.

People who are interested in market timing believe that by using both fundamental and technical analysis, they can predict the direction of the market. Some market timers deal in minutes while others deal in months but it is always short term. Let’s look at why market timing can be dangerous.

At the time that I’m writing this article, earnings season for the 2nd quarter of 2009. If I was a market timer, I might buy 10,000 shares of Walmart because I believe that they are going to report better than expected earnings and as a result, their stock is going to go up substantially, at least for the short term.

Another example may be that while looking at a chart for Exxon, I noticed that it has bounced off of it’s technical support level twice in the last 3 weeks and it is once again at that level. I buy 5,000 shares because I believe that it will once again move up because that has been the trend. I will sell both of these positions in a matter of a day or two.

Both of these examples of market timing have the potential for upside but also extreme downside. If Walmart reports earnings that are lower than expectations, I stand to lose a lot of money. If Exxon breaks through it’s technical support level, it has a high potential to go down fast and again, you will lose major money.

If market timing has so much risk, how does anybody make money doing it? Because the pros have hedging on their side. For our Walmart trade, the pros would buy 10,000 shares of Walmart (the pros would actually buy much more) but also a certain amount of put options. The put options would pay the investor if Walmart’s earnings came in low.

Hedging requires that our $50,000 Walmart position have twice that amount, or close to it, to protect ourselves. Market timing takes a lot of money to make money and it requires a knowledge of advanced investing techniques not normally well known by the beginning investor.

The statistics are clear: Market timing done by the retail (part time) investor almost always leads to long term losses. While you may hit a couple of big ones, the overall performance of your portfolio will not be good if you use market timing as your strategy. Stay will long term investments in safe, dividend paying stocks.

If you’re like me, keep a small amount of money off to the side if you can’t resist the excitement.

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