Market timing: A worthwhile strategy?

Abstract

This study investigated the risks and returns associated with market timing investment strategies on the Johannesburg and New York Stock Exchanges. A framework for assessing the risks associated with market timing was developed. It was confirmed that the longer the review period, the lower the potential rewards available to market timers and the higher the required accuracy rates in forecasting. Shorter review periods therefore appear to be more favourable. Potential gains could be reduced by the increased transaction costs which result when the timing interval is decreased. Simulation of distributions of returns at various levels of predictive accuracy indicated that shorter review periods were not as risky as long timing intervals. A measure of overall risk, incorporating the risk of forecasting wrongly as well as the conventional measure of portfolio risk, was established. Plotting the risk/return profile of market timers, given a level of predictive accuracy, indicated that under all levels of accuracy, the simulated portfolio risk was substantially lower than that resulting from a buy-and-hold strategy. It would appear that timing abilities of approximately 70% are required to exceed a risk adjusted return resulting from holding the market index over the 23 year period studied. It was also shown to be riskier, and the rewards were lower, to diversify across time in comparison with a strategy of diversification within each time period. Timing on the NYSE appeared to be less risky than timing on the JSE but this result was perhaps a function of the investment period which was used.