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Should you time the market?

by Wisdom Seeker 2 months ago in investing
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Should you try and time your entry in the market? If so, how should one go about it? Let’s explore.

Should you time the market?
Photo by Tyler Harris on Unsplash

Disclaimer: This article is not financial advice or recommendation of any sort and may be considered opinionated. Please consult a financial advisor before making any investment decisions.

Should you time the market? This question is frequently seen floating around the web, and the internet seems to be divided on this topic.

If you ask me, my answer would be "It depends". Curious as to why? Read along.

Before moving ahead, let me clarify that this post is targeted at investors, not traders. Trading, by its very nature, requires you to time the market and get the most out of the volatility. So, for a trader, the article ends here.

From an investor's standpoint, there is no 'one' correct answer to this question. It depends on your investment goals, investment philosophy, investment horizon, the macroeconomic conditions, etc.

Stock picking is an art in itself, and I'll cover that in a later post. In this analysis, we assume you are investing in fundamentally strong stocks or indices or mutual funds/ETFs.

To have a better understanding, we can analyze some scenarios.

Scenario 1 : You are investing in an index (say, the Nifty 50 or the S&P 500) through an automated SIP. It's recommended to continue the same even in a correction phase or bear market. SIP provides the advantage of rupee cost averaging (this ensures that you buy more units when the markets are low and fewer units when they are high). But then you encounter a day when the index falls by 4%. What you could do is to make a lumpsum amount in addition to the planned SIP amount to take advantage of the dip.

Scenario 2 : You are invested in a stock and it corrected a lot. Before jumping in to time the market, ask yourself these fundamental questions.

  1. Is this a temporary drop in stock sentiment (say, because a chemical plant caught fire)? - Buying the dip should help in the long term.
  2. Is this because of something fundamentally affecting the business (falling revenues, misallocation of capital, etc.)? - It might be beneficial to analyze further or wait for some quarterly results before making the investment.

Generally speaking, a bear market is an opportunity to accumulate good quality companies at cheaper prices.

Investing generally refers to staying invested in the markets for long durations. But, "long" is subjective - for some, it could be a year, but for another, it could be 10+ years. According to many great investors, a time duration of less than 3 years is not considered investing, but let’s consider all categories of investors - from short-term to ultra-long term holders.

Scenario 3 : If you have a 10+ year horizon, a poorly timed entry wouldn’t impact much as time is in your favor. Remember, for an investor, time is your friend

Scenario 4 : But let’s say you are investing for a short-term goal and you need the money next year. You spot a dip and misunderstand it as an opportunity. This bad timing could have a major impact on your portfolio as time is not in your favor. Let’s say the company couldn't produce the revenues it was forecasting, then the market would punish the stock by dragging it further down. You will be forced to exit at a heavy loss in this scenario.

Even if you could hold on for another year without exiting the stock, there is no guarantee the market will bounce back in this period. A bear market could span over years.

Borrowing the words of economist John Maynard Keynes -

"Markets can stay irrational longer than you can stay solvent."

Scenario 5 : What if the world is going through an economic crisis, and equity markets are plummeting? You notice the stock you have been wanting also falls a lot. Should you blindly invest now?

If you are capable of analyzing the valuations of a company, a smart entry point would be when you feel the company is fairly valued based on the revenues it is generating and its future prospects (I will publish a post later on how to derive valuations). But people tend to bottom fish, i.e., wait for the market to completely bottom out before investing. You may be able to do it once or twice, but in reality, no one knows how much the markets will fall. You could draw any number of support and resistance lines and pour in technical analysis magic and still wouldn’t be able to predict it (and don't believe anyone claiming to know the accurate rebound point). If you wait for the bottom, you might miss your opportunity to enter the stock.

To illustrate this, let's assume stock A was trading at 100. The market is bearish and the stock fell to 90 and fell further to 85. You wait for the stock to touch 80 as you believe that’s the bottom point (or some stock guru you follow does). However, the stock has now rebounded to 90. You change your view and decide to buy once it dips again to 85. But the stock rises to 95, then to 100, and then blasts upward to 110. You essentially lost the opportunity to grab the stock at a discounted price fishing for the bottom.

So, what’s my take on this? Need a simplified view? Sure.

If you are a short-term investor (around a year or so), timing the market could work for you. But at the same time, be ready to book losses if you make a bad timed entry or if the market conditions turn against you.

If you are an long term investor who keeps track of market movements frequently and invests based on market conditions and opportunities or has irregular cashflow, a staggered form of investing is the preferred approach. Assume you have 10k to invest. Once the market or stock is relatively cheap, deploy it in tranches (let’s say 5). The first 2k is deployed when the market falls 5%, the second when it falls 10%, and so on. Sometimes, the market might rebound before you can invest the entire capital, but that's better than investing the entire amount on the initial dip and the market falling another 25% while you have no capital left to invest.

If you are more of an long term 'invest and forget' investor who is not up to date on market trends, a simple and efficient approach is to simply continue your SIPs in stocks, mutual funds, or index funds/ETFs.

If you invest regularly via SIP but would like to take advantage of market opportunities as well, just continue the SIP and on days where you could spot a market dip, deploy extra capital available as a lumpsum, which will give you an added edge.

That's all folks. Thanks for reading :)

The apps I use for investing - Zerodha and Upstox (For Indian equity investing), IndMoney (For US investing), Paytm Money (For mutual funds)

investing

About the author

Wisdom Seeker

Trying to master the art of equity investing

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