Do you fancy timing the markets?
One question that investment advisors get asked usually specifically during market crises is “Since markets are falling, is it better to sell all my stocks now and re-invest when markets are about to pick up?” In short, the investor wants to time the market, ensure that he/she is selling just when the panic has set in and start buying again when conditions are about to improve.
“The average investor’s return is significantly lower than market indices due primarily to market timing.”
–Nobel laureate Daniel Kahneman
We decided to test this out in Indian market conditions, the results are presented below.
We started by selecting the Nifty 500 index as the proxy for the market. The index represents the top 500 companies based on full market capitalization and covers 92% of the total market capitalization of companies listed on the NSE.
We considered data for the index between 2nd January 1995 and 25th Oct 2023, this consists of 7517 trading days. Between these days the index has surged by 1624.2% and returned 10.4% on a compounded basis (CAGR).
Now all markets will have days of exceptional gains and losses. On 18th May 2009, just as the global financial crisis was ending, the index closed up 459 points, gaining 16.2%. This has been the largest single-day gain for the index. On 23rd March 2020, on the first day of the related lockdown, the index closed down by 917 points, losing 12.8%. This is the biggest single-day loss for the index. Looks like if an investor had anticipated that the global financial crisis was ending or that lockdown would be imposed, he/she could have placed trades accordingly. However hindsight is always 20/20, correct?
The best way to time the market would be to stay invested during all the days the market closes in the green and stay out on all the days the market closes in the red. Let’s test this theory for a limited number of times, 100 days.
If we were to somehow not be invested in the market during the worst 100 days of returns, the returns of the index since 1995 would be 16.6% compounded annually. On the other hand if we were to not be invested during the best 100 days of returns, the returns would drop down to 5.3%. If we were to be able to avoid both the best and the worst 100 days the overall returns would improve from CAGR 10.4% to 11.2%.
| Particulars | Invested on all 7517 trading days | Not invested in the worst 100 days | Not invested in the best or worst 100 days | Not invested on the best or worst 100 days |
|---|---|---|---|---|
| Nifty 500 CAGR | 10.4% | 5.3% | 16.6% | 11.2% |
| Difference | – | -5.1% | 6.2% | 0.9% |
“There are only two types of people when it comes to timing the markets:
(1) People who cannot do it, (2) People who have not realized that they cannot do it.”
– Terry Smith, founder of Fundsmith
Let’s suppose we attempt to improve our earnings to 11.2%, by avoiding both the best and the worst 100 days. The biggest impediment to that is the clustering of the best and worst trading days.
As can be seen from the chart below, the best and worst trading are clustered together. We had quite a few good and bad days between 1998 and 2000 as well as between 2007 and 2009. In fact just 6 years, 1998 – 2000 and 2007 – 2009 account for 66 of the 100 best days. This time frame also saw 60 of the worst trading days in the history of the Nifty 500 index.
More recently just 2 months – March and April 2020 saw 6 of the 100 best days as well as worst days.
Conventional wisdom would suggest that most of the best days will occur during the bull phase and most of the worst days will occur during the bear phase of the market.
The above table confirms that theory, 63% of all the worst trading days occurred during the bear phase of the market. However, it is interesting to note that 56% of the best trading days also occurred during the bear phase of the market.
The above table shows that the bull phases were a lot less volatile and had significantly less number of best and worst days, in spite of lasting more than the bear phase.
Investors instinctively understand “buying low and selling high”. However, even with the best tools at one’s disposal, it is not possible to consistently foretell stock market trends. While big market moves do come in clusters, their return behaviour is quite erratic and difficult to predict. Hence the only way to make money consistently in equities is to spend more time in the market rather than timing the markets.
Disclaimer: Investment in securities market are subject to market risks. Read all the related documents carefully before investing. Registration granted by SEBI, membership of a SEBI recognized supervisory body (if any) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.
The content in these posts/articles is for informational and educational purposes only and should not be construed as professional financial advice and nor to be construed as an offer to buy /sell or the solicitation of an offer to buy/sell any security or financial products.Users must make their own investment decisions based on their specific investment objective and financial position and using such independent advisors as they believe necessary.
Windmill Capital TeamWindmill Capital Private Limited is a SEBI registered research analyst (Regn. No. INH200007645) based in Bengaluru at No 51 Le Parc Richmonde, Richmond Road, Shanthala Nagar, Bangalore, Karnataka – 560025 creating Thematic & Quantamental curated stock/ETF portfolios. Data analysis is the heart and soul behind our portfolio construction & with 50+ offerings, we have something for everyone. CIN of the company is U74999KA2020PTC132398. For more information and disclosures, visit our disclosures page here.
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