Does Market Timing Work? Top Reasons It Doesn't

This article is an excerpt from the Shortform book guide to "The Intelligent Investor" by Benjamin Graham. Shortform has the world's best summaries and analyses of books you should be reading.

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Does market timing work? Is it a good or bad investment strategy, and what does Benjamin Graham say about it in The Intelligent Investor?

Market timing is a popular strategy. But does market timing work? While Market Timing is a popular strategy, Benjamin Graham actually argues that it’s a form of speculation, and should be avoided.

So does market timing work? Keep reading to find out the pros and cons.

Does Market Timing Work?

Marketing timing is popular. But does market timing work? Market timing has a strong allure: buy when the market is down, and sell when the market is up. The trouble is determining when exactly the bottom or the peak of a market is. This often seems obvious in retrospect but is exceedingly difficult to predict in the future.

Graham argues that market timing is so unreliable that it should be considered speculation. There is little evidence that any individual investor should be able to beat the overall market at market timing.

Why Do People Like Market Timing?

Speculators are drawn to market timing for a variety of reasons, and don’t usually stop to ask “does market timing work?”

They are impatient to do something in the market and to have some opinion about the market. It’s less entertaining to sit idly until stocks fall under your criteria for a bargain.
They have an arrogant presumption that if you’re smart enough, you can predict how the market will move. Investment “experts” profess to have these clairvoyant powers and put out endless predictions daily, but in reality they are woefully inaccurate.
Compared to the hard work of evaluating a business’s fundamental value, market timing is relatively simple—guess whether the market is too high or too low, and sell accordingly.

Why Doesn’t Market Timing Work?

Now that we know the answer to the question “does market timing work?” you can ask why not. Simple mathematical formulas to determine whether the market is at a peak or bottom (such as relying on overall price-to-earnings ratios) tend not to work. There are two major reasons why:

A formula may seem to work when backtesting across past years or decades. However, it may simply have been illusory—a pattern fitting due to random chance, or a strategy that worked in an idiosyncratic period—and provide no predictive power going forward.
The formula may indeed have worked in history, but if a strategy provides a real advantage in the market and is simple to execute, it will be adopted so quickly and widely that it loses its advantage. (Shortform note: The advantage disappears because if enough people adopt the formula, market prices will adjust in an unfavorable way. For example, a formula may predict when a market’s bottom is and thus when to buy. If enough people buy at that point, prices will rise, meaning the stocks are no longer a bargain and there is less room for the price to appreciate.)

Any simple formula that can be easily adopted by the market most likely does not present an advantage over the long term.

Graham comments on how, in the first half of the 20th century, there were ten market cycles running from high to low and back again. Most bull markets fit a certain pattern, such as having a high price level, high price/earnings ratios, and a high number of low-quality stock offerings. Seeing these warning signs of the top of a bull market, an investor might reasonably sell and wait for the market to turn.

However, this pattern didn’t fit all cycles, such as the bull market of the late 1920s or the postwar market from 1950 to 1970. During these times, the market soared beyond warning signs that applied in previous cycles. An investor trusting these signals would have sat out much of the market’s growth. Even worse, an investor might get so uncomfortable seeing the market leave him behind that he abandons all caution and buys into the market, right at the point at which it is overvalued and really due for a downturn.

So does market timing work? In The Intelligent Investor, Benjamin Graham says no.

Does Market Timing Work? Top Reasons It Doesn’t