Timing Risk

Posted in Finance, Accounting and Economics Terms, Total Reads: 313

Definition: Timing Risk

Most investors do not trade on every other news that happens every day. Many of them stay invested for long period of time without heeding to short term disturbances. However, markets though steady in the long run, happen to be highly volatile sometimes. The large spikes might lead the investors to invest/divest heavily only to realise that it was a foolish decision. Hence timing the markets is a huge risk especially in the present period of fluctuations.

Choosing when to invest and time the market is difficult. Investors if they are not careful might miss out on such periods of exceptional returns. Though market movements are difficult to predict, there are always indicators that point towards an uptrend even though they are not always correct. A careful analysis need to be done and complementary indicators must be checked to confirm the trend. Missing such a trend might be very disastrous as shown in the figure. We analyse the S&P 500 index as a proxy for the broader market performance, we see that a fully invested person makes a gain of 8.21% over a period of 20 years i.e., from 1990 to the year 2009. However, the returns realised by a investor who just missed 10 days out of this period would realise a low return of 4.51% and someone who missed 40 best days would actually lose out his entire investment.

Thus market volatility if not managed properly, it can diminish the returns from investments. Since the economy is a highly complex system with thousands of parameters affecting it. It may be close to impossible to time the market exactly. Also since the Efficient Market Hypothesis also predicts that Timing the market is impossible, the risk of wrong timing is much more especially in case of developed financial markets like USA



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