Buying shares when the price goes down 2% and selling shares when it goes up 2%

Last summer (2019) I actually tried modelling something like this approach using FTSE 100 date from October 1997 to July 2019¹, because I, too, felt "intuitively" it might work...

...unfortunately, it never did so consistently.

After playing around in a spreadsheet, trying different rates for when to (partially) sell after the market had gone up (the "cream rate" as I called it), or when to reinvest after the market had fallen (what I called the "remix rate"), I wrote a program to cycle through lots of combinations of the two rates.

My findings were that for many time periods, you could find a pair of cream/remix rates which would outperform just leaving your money invested. However, there was no consistency to the choice of rates: rates that would be a win for one period would lose money for a different period (and vice versa). No choice of rates (e.g. the 2%/2% you mention) would consistently do better than just leaving things invested.

My conclusion was that – while I don't think this approach is really "timing the market" by its usual definition – it is just as unreliable. You might "get out" after a certain amount of upswing, but there's no telling whether the market will continue rising (in which case you've missed out on more gains) or will drop. Similar arguments apply for getting back in after a fall in the market.

(Also, I didn't take into account trading costs: depending on how much the market fluctuates, and where your "cream/remix" rates are positioned, frequent trading might eat into whatever gains you might make).

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¹ Data taken from probably an earlier version of Historic Closing Values spreadsheet (XLSX, 540kB) link on the FTSE Statistics page.

The context determines whether this is a viable idea.

Suppose there's a security that you like at the current price. As an investor, you want to buy it and hold for long term appreciation. If you trade it, you may scalp some trades but if price moves up after you sell and book a profit, your opportunity is gone.

Scenario 2 is that you, as the investor, scalp some profits and then share price drops significantly. Now you are holding a security that you were willing to own and you are now holding for a recovery, possibly long term. No problem.

Scenario 3 is that you are a trader. Scalp your profits and if XYZ moves up and away, move onto another security. There are many, many others to choose from. The trader's problem is when price collapses during ownership and now he becomes a bag holder. His capital is tied up and he faces the choice of becoming a Buy & Hope investor or selling the position and booking the loss.

In a volatile market like the past month, the scalping idea works much better because the swings are larger, with price often retracing several times a day.

What is the problem, if any, of selling when it goes up 2% and then buying back in when it goes down 2%?

The problem is when the market goes up 10% and you cashed out at 2% because you thought it was going to go back down. You miss out on that 8% upswing waiting for that 2% dip that just isn't happening. On the other side, you buy in on a 2% downswing, but it keeps going down by 10%. Odds are good that the market will eventually come back up, and if you are patient, no loss. But this side works because you are in the market, rather than trying to time it.

"But wait! I won't cash out at 2% upswing if it's still going up!" Ok, fine. You wait for a "peak". You'll cash out when it goes up past 2% of your basis, but then ends the day down. Of course, just one down day will boot you out of your position, even though it could zoom up another 10% right after.

"Ok, I'll be smarter at identifying the top. I'll use technical analysis and look for support, shoulders, etc." Well, you can see where this is going, I hope.

Just to give an idea of how hard it is to know when to buy, I was hoping to buy into the bottom of the market. If I had a crystal ball, I would have seen that the bottom was on March 23rd, where the DJIA had lost more than 30% off its high water mark for the year. But on March 23rd, I was thinking: "It will get worse, because most states have not reached their covid-19 death peak. Buyer sentiment will sour when soaring death reports roll in." And so when it came back up, I sat it out. Now the market has recovered considerably and remains stubbornly high relative to that low. Fed intervention seems to be buoying optimism. Will it go down again? Will it keep going up? Pretty hard to say.

If you think this is a good idea, implement it as a paper trade. Go back as far as you like, applying your rule(s) religiously, and see how much profit you would have made. In the event that the market oscillates up and down by 2% over a short time period, this strategy is an absolute killer. For other scenarios (i.e., the real world), the net profit is...less clear, as TripeHound explains.

EDIT

You can download historical prices pretty easily from Yahoo! Finance, such as this data for DJI (click the Download Data button for a nice CSV file). If you have any programming experience, it should be pretty trivial to write a script which implements whatever rule you imagine and executes virtual historical trades to see what your final profit would have been. This is much better than applying a rule manually, because the program will be ruthless and blindly apply the rule even in obviously bad situations. Given that "obviously bad" only applies with the magnifying 20/20 vision of hindsight, it is pretty important to apply whatever rule you invent consistently. This is clearly the kind of process described by TripeHound.

what it certainly does is fluctuate up or down.

Citation needed there. You have simply asserted without evidence that fluctuations of 2% up and down are a 100% mathematical certainty, but this claim requires evidence to be supported. Do some historical analysis; is it true?

What is the problem, if any, of selling when it goes up 2% and then buying back in when it goes down 2%?

Assuming that it both goes up 2% and down 2%, in that order, forever, there is no problem at all. However you have not said what you'd do if it went up 2%, you sold, it went up 2% again, you sold, and you kept selling until you had nothing left, and the market never went down to 2% below your last purchase. Now you've got a big pile of cash sitting there losing value to inflation. When exactly do you buy back in? Your strategy does not say.

Surely you could do this many times a year?

You tell us! Look at historical records; how many times could you have executed such trades in the past to advantage? Look at the last, say, fifty years and see.

Barring crashes in the market, which means you hold for recovery, I can't see a downside myself.

Barring icebergs, the Titanic -- which sank on this day in 1912 after striking an iceberg -- would have had a successful maiden voyage as well. Saying "barring crashes" while we are in the midst of an enormous crash is an odd thing to say.

You say that your crash plan is to "wait for recovery"; recovery can take over a decade easily enough, so, what's your strategy during that decade? It sounds like "hold onto a bunch of stocks that I overpaid for and am never going to sell" is your strategy for handling downturns. It's not a terrible strategy, but you've got to be realistic about the fact that you might own an asset for literally decades that you cannot sell at a profit.

Other answers have gone into some details about why this scheme is not likely to work. But there's a much simpler way to view it: If such a simple, obvious method could really work, why isn't everyone doing it? Are all the financial planners and quantitative analysts so dumb that they can't couldn't see this clear way to riches?

There's no magic formula you can use to time the market. In the long run the market has always gone up, so "buy and hold" is often the best policy. The secret is picking the right things to buy in the first place. You don't have to hold everything forever -- make intelligent decisions on whether a particular holding still seems wise (would you buy it now if you didn't already hold it?) and sell if not (but don't forget to account for trading costs and tax implications). This was the subject of Peter Lynch's classic books Beating the Street and One Up On Wall Street.

More generally, it's not really possible for any automatic strategy to win in the long run. Remember that in order to make any transactions, you have to have buyers and sellers. If there were a system like this, the majority of traders would adopt it. They would all see the same "buy" signal at the same time, so none of them would be willing to sell, so there won't be anyone to buy from; the same thing when a "sell" signal is seen. There may be some investors who can't follow the system because of personal circumstances, but you'd have to be lucky to match up with them enough to make the system work.

It sounds like you're talking about trading on volatility. High Frequency Traders can make it work by working on extremely small margins (like 0.01% price fluctuations), high volumes and having very low transaction costs. They can also arbitrage price differences at different exchanges. Those opportunities are not available to you and me.

Fluctuations of 2% are much less common, and as other answers have covered, you never know if a 2% rise will be followed by another 2% rise. If I bought and sold on 0.01% price fluctuations, my brokerage fee of 0.2% would swamp any gains I hoped to make.

In another answer it mentions running a simulation of this. I replicated their results and the output is short enough to include in an answer:

Trade Date      Price   Investment Value Comment  
Buy  20/10/1997 5211.02 1000.00
Sell 27/01/1998 5326.31 1022.12
Buy  01/09/1998 5169.14 1022.12
Sell 07/09/1998 5347.03 1057.29
Buy  10/09/1998 5136.57 1057.29
Sell 14/09/1998 5268.61 1084.47
Buy  17/09/1998 5132.89 1084.47
Sell 20/10/1998 5251.88 1109.61  Prices then rose for a couple of years
Buy  07/09/2001 5070.29 1109.61
Sell 17/10/2001 5203.41 1138.75  With prices flat, there are many trades
Buy  19/10/2001 5017.69 1138.75
Sell 23/10/2001 5193.34 1178.61
Buy  25/10/2001 5086.59 1178.61
Sell 26/10/2001 5188.65 1202.26
Buy  30/10/2001 5003.6  1202.26
Sell 02/11/2001 5129.54 1232.52
Buy  20/02/2002 5024.15 1232.52
Sell 26/02/2002 5138.95 1260.68
Buy  05/06/2002 4989.15 1260.68     But wait three years for the upturn
Sell 22/06/2005 5099.28 1288.51     Then have to wait for the financial crisis
Buy  17/09/2008 4912.36 1288.51
Sell 19/09/2008 5311.33 1393.16    Lots of volatility = trading
Buy  23/09/2008 5136.12 1393.16
Sell 14/10/2009 5256.1  1425.70
Buy  28/10/2009 5080.42 1425.70
Sell 09/11/2009 5235.18 1469.13
Buy  05/02/2010 5060.92 1469.13
Sell 15/02/2010 5167.47 1500.06
Buy  21/05/2010 5062.93 1500.06
Sell 27/05/2010 5195.17 1539.25
Buy  07/06/2010 5069.06 1539.25
Sell 14/06/2010 5202.13 1579.65
Buy  25/06/2010 5046.47 1579.65
Sell 12/07/2010 5167.02 1617.39
Buy  10/08/2011 5007.16 1617.39
Sell 11/08/2011 5162.83 1667.67
Buy  19/08/2011 5040.76 1667.67
Sell 24/08/2011 5205.85 1722.29
Buy  22/09/2011 5041.61 1722.29
Sell 27/09/2011 5294.05 1808.53
Buy  30/09/2011 5128.48 1808.53
Sell 06/10/2011 5291.26 1865.93
Buy  23/11/2011 5139.78 1865.93   Now the markets are emerging and growth
Sell 28/11/2011 5312.76 1928.73   is returning.
Buy  16/03/2020 5151.08 1928.73   We have to wait for CV19 to lower prices
Sell 17/03/2020 5294.9  1982.58
Buy  18/03/2020 5080.58 1982.58
Sell 20/03/2020 5190.78 2025.58
Buy  23/03/2020 4993.89 2025.58
Sell 24/03/2020 5446.01 2208.97   

It illustrates many of the features that have been discussed in other answers:

Yes, you do make money. From 1997 to the end of March 2020 an initial investment of £1000 has yielded £2200

The final trade, makes this look good, had we finished a before COVID we would have had less than 2000 at the end, and by varying from 2% to other values that is the typical return that this strategy would give over this period. That is an AER of about 3%. A savings account would have done better over the 23½ years.

But there are very long periods in which your cash is sitting doing nothing. For example on the 28 of November 2011 you sold your stock for just under £2000, and kept it as cash until the crash in March of this year. That is a nearly decade of waiting for the price to drop.

If you scroll through, you will see that you make lots of trades during times of crisis. When the prices are "doing well" you tend to all your money in cash, waiting for the next drop.

This strategy has done "better than the market" over the period due to the repeated rises and falls in the FTSE. The index has risen to about 7000 on three occasions and then dropped back on three occasions. If the exercise had been done using the data from 1984-2000 (during which time the market generally rose) it would have done substantially worse.

_{Source at https://github.com/zeimusu/airtrader}