Traditionally, market timing consists of shifting from stock and or bonds to more secure or safe instrument having less risk (i.e., Treasury bills). Managers using this strategy either use fundamental or quantitative analyses to make their decisions.
Market timing often refers to buying securities at a low price and reselling them at a higher price. the thematic behind this strategy is attempting to predict the future movement of stock prices using either technical or fundamental analysis.
However, Fama (1965) coined the efficient market hypothesis suggesting that trying to time the market is futile and markets are efficient. Fama’s suggestion is to simply buy the index. This notion is similar to betting on an entire horse race rather than just betting on one horse.
Markets are efficient and it is impossible to predict where the market will be; therefore, when information becomes available, it is instantly incorporated into the stock market. Consequently any type of mathematic models trying to forecast the market’s direction will not work.
Markets follow a random walk and according to Malkiel (2006), foreseeing where the market will be in the future with some sort of reasonable efficiency and persistency over the long term is not possible. Hedge fund managers on the other hand believe that markets are inefficient and do not behave as a random walk.
A good market timer must predict the exit and the entry to be successful. Ellis (2002) calls this loser’s game by undertaking to outperform the market over the long term. The longer the horizon the more difficult it is for money managers to consistently outperform the market.
According to Bauer and Dahlquist (2001), buy and hold strategies using large cap stocks outperformed a market-timing strategy almost 99.8% of the time. The authors used backtested simulations with monthly, quarterly, and annual market-timing strategies during the 1926–1999 period for six wellknown and major U.S. asset classes.
However, Shen (2002) highlights that adhering to some general rules may be possible to avoid a number of market downturns by focusing on the spreads between the earnings price ratio (or earnings yield of an investment) of the S&P 500 index and interest rates.