Timing the market with a twist

More or less, you reach this goal with rebalancing:

If you hold, say, 70% of your assets in stocks, 20% in bonds and 10% in cash, when the stocks go down by 20%, you readjust by buying more stocks until you have the above ratio back.

OTOH, if your stocks go up by 30%, you readjust again, e. g. by selling some of your stocks.

The same holds for bonds.

The problem is, as usual, finding the right time to do this: do you do it based on some triggers? Or in regular time intervals?

The problem remains: Whenever you buy, you cannot be sure that the prices won't go even more down, making you miss an opportunity. And whenever you sell, you cannot be sure that the prices won't go up in the next days or weeks.

Whenever there is an economic downturn (as evidenced simply by a majority of economists saying: "hey, we're in a downturn") you invest your money into a diversified portfolio that closely resembles the economy as a whole. Now you wait until there is a upswing (as evidenced simply by a majority of economists saying: "hey, we're in a upswing") and you cash it all out. Rinse and repeat.

You can't time the market but yet you just described timing the market.

So, you have lots of cash available. Along comes a 2000 or a 2008-2009 when the market dropped 50% over 15-18 months. Do you invest when it's down 10% while it's on the way to down another 40%? At 20% down? At 30% down? What happens if you don't invest when the market is down say 20% and it reverses sharply? All you then have is still your cash, eh?

Or consider the opposite. The DJIA bottomed out at 6,800 and then rose to 29,000. How would you know that 15,000 or 20,000 or any number was the high point? If you thought so and cashed out, how many years might you have to wait until it retraced to a buy level, if ever?

There are a number of ways to achieve your "low risk, low reward kind of strategy." It involves options and hedging. Rather than guess what the market is going to do, you actually let what the market does determine your actions.

Describing hedging in detail is beyond the scope of this space. What I achieve with such hedging is playing in the middle or as you stated, a "low risk, low reward kind of strategy" - but significantly more upside potential than fixed income. I own some large large cap stocks bought this year that have lost 1/3 to 1/2 their value to date and yet my retirement portfolio is slightly up for the year. Nothing to brag about but given the circumstances, I'll take it.

Most investors only look at the reward side of investing and completely disregard any form of risk management. In a nutshell, here's what I have learned in 40 years:

• 1987 taught me that the market can take a lot of money away from your rather quickly.

• 2000 taught me that one can indeed get out of the way of a 50% drop in the market long before the bottom.

• 2008 taught me that not only can you get out of the way of a 50% drop in the market but you can also make really good money when the market craters.

Also worth noting on top of these other excellent answers that this way of thinking can also get you into weird gamblers fallacy territory quickly. A random walk on coin flips has substantial dips below expectation (eg long runs with many more tails than heads and vice versa) but buying heads after long strings of tails isn't a positive expectation bet even if you define the entry and exit points nice and cleanly as n number of standard deviations away from normal etc.

You're mistakenly thinking that good news in the present indicates bad news in the future, and bad news in the present indicates good news in the future.

In reality, the expected return of the stock market is pretty much independent of what has happened before. There are some correlations, but they're too weak to really suggest any viable strategies other than buy-and-hold.

It sounds like you've noticed that in the stock market, every period of increase is followed by a period of decrease, and every period of decrease is followed by a period of increase. However, that's a totally vacuous and meaningless observation, because in any possible time series (except for those which eventually stop increasing or stop decreasing), every period of increase is followed by a period of decrease and vice versa.

If you stand by a roulette wheel and start making a chart that increases when the wheel comes up red and decreases when it comes up black, it'll look a lot like a stock price chart. It'll have fluctuations and cycles just like the stock market does.

The problem is that if you know that the market has gone up recently, you have no way of knowing whether we're in the middle of a period of increase or at the end of one. Both possibilities are equally likely, so the information about what the stock market has done lately is useless.

I found my answer elsewhere:

No it is not viable as an investment strategy.

I guess what I'm asking is: Could you leverage the fluctuations by themselves, without knowing anything else but: "what goes up must come down and vice versa".

Yes you can identify predictable price fluctuations in many corners of the economy. And no, "knowing when the peak will be, or how high or low it would be" would not be required to make a profit in such a situation, so you actually wouldn't be timing the market. But that wouldn't matter because even in a theoretical perfect setting without any additional costs or constraints, the best you can ever hope for is to break even. Anything more would be dumb luck.

Because even if you're not timing the market, you are still beating the market. And that requires that you know something the others do not. And because in your scenario everyone is seeing the same fluctuations you are, this is simply not the case. This, like timing the market and other would be strategies, all boils down to Efficient Market Hypothesis.

Some algorithms do indeed exploit fluctuations much in the way you describe, but this is not where the value is. The value is in identifying what fluctuations to exploit.

The main problem with your proposal is that the length of bull markets vary hugely, and can extend for more than 10 years. If you cash out the minute some economist or news outlet says we’re in an upswing, then you’ll miss the vast majority of gains.

Whenever there is an economic downturn (as evidenced simply by a majority of economists saying: "hey, we're in a downturn") you invest your money into a diversified portfolio that closely resembles the economy as a whole. Now you wait until there is a upswing (as evidenced simply by a majority of economists saying: "hey, we're in a upswing") and you cash it all out. Rinse and repeat.

The problem here is "cash it all out". Stocks yield 7-8% in the long run. Currently, in many parts of the world, interest rates are near zero or even negative.

So, stocks have an inherent 7-8% advantage over bonds in the current low interest rate regime. In 3 years (accrued interest), that is 23%-26% advantage.

Now, if you can time the market so well that you can time the peak at an accuracy of 3 years (most can't), it works only if the drop in stock prices is over 23%-26% -- otherwise you're making a loss compared to all-stocks all-the-time portfolio.

I agree that it is a good idea to invest more in times when stock prices are low and invest less in times when stock prices are high. For example, when the coronavirus crisis started, I deposited all my physical cash to my bank account, started to use credit cards for all daily purchases (at that time I decided to purchase only food and not any durable goods such as bicycling or camera gear which I occasionally purchase) in order to have as much buying power for stocks as I can have, and invested nearly all of the free money I had into stocks. In hindsight, that turned out to be a good idea. Yet, when I encouraged others to do the same here at money.stackexchange.com, some of my answers were downvoted by prophets of doom. Those prophets of doom made my desire to purchase stocks even greater -- generally, when nearly everyone is fearful of stocks, is the best time to purchase stocks.

It has been said:

Be fearful when others are greedy, and be greedy only when others are fearful.

When the stock prices recovered faster than I expected, I started to buy again camera gear and bicycling gear. I stopped my regular investments to stocks as my strategy of increasing my portfolio size all the time was taken care of increasing valuations of stocks. I also sold all of my ownership in Tesla for 1750 USD / stock, as I could no longer justify its valuation at that price. Yet I did not sell any stocks other than Tesla, because even though their valuations recovered, I cannot say that the valuations are clearly too high.

At some point of time, I'll probably have lots of free money again and I have to resume buying stocks (other than Tesla unless the valuation of Tesla normalizes).

What you're describing is an investment strategy known as buying on a Really Bad Day. This is discussed many times on the Boggleheads forum, and is well worth researching. I think that the general consensus is that the RBD strategy doesn't beat the baseline much. And certainly not that much to worry about.

Differentiate this from a simple re-balancing strategy. If the share market moves higher, then the balance of shares to bonds will now be skewed towards shares. Re-balancing involves selling shares and buying bonds. Essentially, this "sells when the market is up". Likewise, when there's a downturn in the share market, your balance is now skewed towards bonds. So sell bonds and buy shares. Ie, buying when the market is low.

This is probably a better strategy for you in the long-term.