Chuck LeBeau

The Dangers of Timing the Market

Buy and Hold is bad advice nowadays and has been for many years. The markets are much too volatile and even quality stocks are subject to large declines. A drawdown study of the S&P 500 stocks conducted by SmartStops.net shows that from January 1998 up to October 10, 2008

There were 61 stocks that had experienced a drawdown of greater than 90%

There were 124 stocks that had experienced a drawdown of greater than 80%

There were 204 stocks that had experienced a drawdown of greater than 70%

There were 305 stocks that had experienced a drawdown of greater than 60%

There were 383 stocks that had experienced a drawdown of greater than 50%

There were 447 stocks that had experienced a drawdown of greater than 40%

The actual result might be even worse because this study is subject to the positive effects of “Survivorship bias” because in this ten-year period there have been a number of stocks that went out of business and were deleted from the Index. These stocks had declines of 100% but are not included in this study.

Buy and Hold ignores any concept of risk vs reward. In today's markets the rewards of Buy and Hold are meager or even negative and as you can see from the quoted study, the risks are very great. In order to have a better reward with less risk market timers do not need to pick tops and bottoms. They just need to generally respect the major trends and limit losses.

A study published by Smart Trade Pro of the S&P 500 from 1984 through 1998 shows that it is much more important to skip the worst days in the market than to enjoy the best days. If you skip both the best and the worst days you will come out way ahead.

Remember that recovery from one of those 50% declines requires a 100% gain just to get back to even. Avoiding big losses is the key to success these days and you sleep much better in the process. Buy and Hold has unlimited risk and keeps you in the market all the time. That might be an acceptable level of risk if the rewards were high enough but my studies at SmartStops.net show that some simple market timing produces higher returns with less risk.