If you listen to the words of wisdom of any marquee investor like Ben Graham, Warren Buffett or Peter Lynch; one thing comes out crystal clear. Most of the long-term returns have been made by these investors with the benefit of time and not by timing the market. What exactly do we understand by Market Timing? When you are timing the market you are actually trying to buy low and sell high. The reason market timing as a strategy does not work consistently is that it is practically impossible to buy at the bottom and sell at the top. A better way to approach equities is to focus on time instead of timing the market.
Time is about giving a longer time frame to the market to discover the value of the stock. Good quality stocks with sound business models, solid growth and robust cash flows eventually will find their price converging towards their fundamental value. That is one of the reasons good quality stocks always help you earn above-market returns over a longer period of time!
Why timing the market does not work for you consistently?
As John Maynard Keynes put it very aptly, "Markets can stay irrational much longer than investors can stay solvent". Quite often, investors and traders ride the momentum, but ordinary investors being rational people tend to look for logic. Therefore they end up selling when they should be buying and they end up buying when they should be selling. Secondly, any trade in the market has to be necessarily placed with a stop loss because every investor's has only finite capital. Hence capital protection becomes the primary objective and that forces individuals to put stop losses when they trading long and also when they are trading short. When you are timing the market, you need to play with stop losses. As a result, on volatile days you tend to hit the stop loss and eventually also reach your target. But that is meaningless as your position has already been terminated.
The third reason why timing your trades does not work is that you eventually end up losing out on the big winners as your perspective is too short and too narrow. Take the example of Bharti Airtel when it listed in 2002 at around Rs.38 and then dipped to a price of Rs.22/-. Many sharp traders who bought the stock at these prices actually booked profits of 30-40% over the next few months. If you thought that was a smart move; remember the stock actually appreciated by over 45 times (Bharti moved from Rs.20 to Rs.950) over the next 5 years. These are the kind of multi-baggers you actually tend to miss out if you focus too much on timing the market.
But, then why does time work favourably in the market
Time here refers to being in the market for the long term. There are 3 reasons why time always works in favour of the investor when it comes to investing in equities. Firstly, markets need time to separate the wheat from the chaff. Even marquee names like Infosys and HDFC Bank took time to be discovered. Markets will assign value when the company delivers superior growth consistently. That is why time always favours investors in the stock markets, especially when you are holding on to high growth stocks. Secondly, valuations are typically based on sustained earnings. Initially P/E ratios are low as markets tries to judge the performance. Once the company delivers consistently, the market not only believes the numbers but also assigns a higher P/E. That is when wealth gets created for investors. Lastly, the beauty about long term is that your business growth tends to get compounded. That is when returns on your investment also get compounded. But that is only possible when you give time to your investments to play out.
Reason for the difference is within you; it is your psychology
It is so easy to say that "One must be greedy when others fearful; and fearful when others are greedy". In practice that is easier said than done. Fear and greed always works unfavourably for investors. They hold on to a stock in hope and end up selling out when the downside risk is almost limited. In the process they miss out on the bounce. Similarly, investors take time to get convinced and by the time they get greedy about the stock, the stock is already atrociously overpriced. The moral of the story is that when you try timing the market, your own human instinct works against you. The better answer, therefore, is not to worry about market timing and just focus on letting time create wealth for you through equities.
Is there an eclectic approach; of timing the market and creating value
An equity mutual fund SIP or "equity SIP" can actually be a kind of eclectic approach. When you continue with a systematic investment plan (SIP) for a longer period of 8-10 years, you invariably tend to earn above-market returns. Here time does work in your favour. But then what about timing your trades? While you will not be exactly timing your trades, the SIP gives you the benefit of rupee cost averaging (RCA). That means when markets correct, you automatically buy more stock or more units. That will reduce your overall cost of acquisition. Thus indirectly it works like a form of market timing. The only difference is that human psychology does not become your biggest roadblock here.
It has been proven time and again that time matters more in the market than timing the market. It is impossible to consistently time that market and that means it is not a useful strategy because anything that cannot be done consistently can be a strategy. Rather, identify good assets, hold on to them for a longer period of time and sit tight through the market vicissitudes. That may a better choice and more fruitful than timing the market.