6 min read
Let’s skip the lengthy intro. The easiest way to lose money in the stock market: Timing the market.
Most day traders don’t want to hear it. They plug their ears and continue to trade anyway. I know a day trader whose losses continue to mount but he keeps doing it anyway because well, he’s addicted to it and it feels so good when he wins.
Let’s talk about the risks of market timing and why you, an amateur trader, may want to adopt a much more boring alternative compared to your current day trading strategy.
The Risks of Market Timing
What is market timing? Just in case you’re new to the idea, market timing means you try to predict when stock prices will rise and fall. In response, you attempt to buy low and sell high.
Here’s an example of how an investor might misfire when trying to time the market: One of the biggest costs of market timing, according to Merrill Lynch, involves selling off equities and putting money in more conservative investments. When you have your money in bonds instead of stocks, the market might enjoy a high-performing period. Oops! You’ve incorrectly timed the market and missed those top months.
Let’s take a look at some other risks.
Risk 1: The stock market is historically more profitable in the long term.
If everyone could predict the markets, everyone would sell right before a crash. At the very bottom of a crash, everyone would scoop up bottom-barrel stocks for cheap prices and know the exact point at which to do it, the very definition of “buying low, selling high.”
So why doesn’t everyone do that? Because nobody knows what the market will do, not even professional traders. Believe it or not, they consider themselves lucky if they get it right more than 50% of the time.
What do you think will happen to you, an amateur trader?
Accumulating real wealth takes decades. The stock market shows its greatest promise not in the short term, but in the long term, over 40 years — not 40 days. Since 1926, stocks have never lost money in any 15-year period. In the short run, you can experience serious dips in the market (just look at the COVID-19 pandemic as evidence of a majorly bumpy ride).
Volatility works both ways. The stock market experiences periods of extreme negative volatility, but there are also periods of extreme positive volatility where the stock market goes through the roof. Again, you could mistime and it could soar — all the while missing out on gains.
Risk 2: You could become overcome by hindsight bias. After all, hindsight is 20/20.
The best time to accurately pinpoint a market high or low point: After it has occurred. If you move your money out of stocks during a low period, you might not move your money back in time. By the time stocks take off on another upswing, you may find yourself long past the point where you can take advantage of gains.
In psychology, we can point to something called hindsight bias, which occurs when you look back and overestimate your ability to have predicted an outcome that you would have been unable to predict before it actually took place.
Who can forget that after the dot-com bubble? Many financial experts pointed to a set of events in retrospect that indicated a strong indicator of a market in trouble.
Moving forward, you might feel like you can pick winners and losers more easily based on what you saw previously in the markets. However, market timing, stock speculation, and general predictions of where things will go will not turn out the same way, based on previous performance and hindsight.
Risk 3: Overconfidence, fear, and greed can get you.
Many traders understand that market timing can incur losses but still might think they’re the exception to the rule. You might think, “Market timing doesn’t work for most people, but I’m not ‘most people and I know the markets like the back of my hand.”
When you predicted market events correctly one time before, you might feel overconfident that you can do it again. Combining overconfidence with this type of decision-making inevitably means you lose money.
Other emotions play into the mix: Fear and greed. When you want to get rich as quickly as possible, the bull market may be a dangling carrot. The dotcom boom and the greed that resulted means that investors scrambled to buy every and all internet-related stock without knowing about the underlying companies. We all know how that ended!
Just as potent as greed, fear can also cause investors to start selling because they fear they’ll lose even more money. Of course, a herd stampeding toward that result means that stock prices fall even further.
Risk 4: Commissions and fees take your money.
Small commissions can add up to a lot of money. For example, if you buy a $15 stock and sell it for $16, you might reduce your $1 profit in one fell swoop, depending on how much your brokerage firm charges you for commissions (aka trading fees).
Risk 5: Taxes kill your profit.
Don’t forget that you have to pay taxes on the money you make. You incur short-term capital gains when you hold onto an investment and then sell it within a 12-month period. Short-term gains get taxed as ordinary income. What does that do to your $1 profit? It might eradicate it altogether.
Does Timing the Market Still Sound Good?
There are no two ways about it: To successfully time the market, you need to know exactly when to yank your money out of the market and when to put it back in.
Unless you have uncanny skills at predicting the very lowest the market can go and know the very highest it will ever go, you’ve entered into a losing proposition. Odds are, you’ve already experienced selling too early and buying back in too late.
Do you still want to risk your hard-earned money?
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