InvestorQ : Timing the market looks so simple, then why is it so difficult in practice?
Anjana Aiyar made post

Timing the market looks so simple, then why is it so difficult in practice?

3 years ago

Timing the market can appear to be quite seductive but it is actually an impractical hope. Nobody catches the tops and bottoms consistently. Here are a few key reasons why timing the market is so hard in practice.

Firstly, stop losses can get triggered due to volatility and due to no fault of yours. One of the main reasons is the stop loss that you put. More often than not, markets never tend to bottom out from a point. They tend to bottom out with a lot of volatility and then tend to stabilize. Your stop loss could get triggered in the volatility or you could just lose patience in the midst of the consolidation. Either ways, it is very difficult for you to time the bottom of the market.

There is a psychological angle to this. You always prefer to trade when stock is showing signs of momentum. That is the point when it has bounced sufficiently from the bottom and well away from the top. That is where most of the trading interest in the stock arises. Even within a trading range, you need to focus more on the profit you make than whether you caught the bottom and the top of the market.

Remember the cases of Lehmann and LTCM. They all tried to time the market and were eventually right. But, as Keynes rightly said, “Markets can be irrational much longer than you and I can be solvent”. You have a capital protection responsibility and that forces you to churn money faster as a trader. The irrationality of the market can, at times, be quite nerve racking forcing out identifying the bottoms and tops of the market. That is the practical side of the story.

There is another reason for this. Remember, tops and bottoms of the market keep shifting. Most of the charts that we use are mere approximations. Charts are not made out of real money but trading is done with real money. Hence, it is hard to predict by how much the tops and bottoms will diverge from the charts. Here again your constraints on stop losses and the need to book profits becomes paramount.

Trading is not about analyzing and charting stocks. Here you put real money. A chartist’s bottom and top may differ from a trader’s bottom and top. You behave differently when your own money is on the block. Most of us act differently when we are analysts compared to when we are actual traders. When we trade we commit real money. Even if the chart sounds very convincing to our logic, it is hard to convince to lose money beyond a point. The trading activity is all about discipline and it does not have place for leeway and flexibility on risk management. It is trading discipline that makes identifying tops and bottoms so hard!

Finally, how long can you wait for the right level. You surely cannot wait till eternity. Timing the market requires waiting for the right level. That is what becomes difficult for traders as the focus is more on churning your funds practically. Why to wait 10 days for a 10% lower price when you can recover that cost by churning your money twice in that that time period. Above all, historically, stock markets returns have never been generated by timing the market. That settles the case!