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Market timing 101: The basics

Market timing has long been viewed as a way to "beat the market" because it selects the best time to be in it and when to be out. There is much controversy over the results.

The goal of market timing is to avoid major drops in market prices and enhance an investment account's value.

Market timing attempts to gain higher returns than other investments with similar risks. It examines the directions of the markets and the forces affecting market changes.

Timing the market

Market timers look at indicators to determine when to buy or sell their shares. Indicators are data points determined by mathematical formulas. When an indicator points to a good time to buy a stock, it is called a buy signal. When an indicator points to a good time to sell a stock, it is called a sell signal.

Indicators used: market averages and moving averages

There are many types of indicators used by market timers. To look at the changes in a market over time, a market average is used. A moving average is an average of data (e.g., closing prices) covering a period of time (e.g., 90 days) going back from the date of calculation and periodically (e.g., weekly) recalculated. (Other time periods may be selected for the calculations.) When a price moves above or below a certain market average, the investor knows when to buy or sell.

Indicators used: market volume

Market volume indicators look to see whether stocks gaining or dropping in price are getting the biggest share of market activity (volume). Volume is the total number of traded shares. Periods of low volume indicate investor indecision. High volumes usually indicate new trends and higher share prices.

Indicators used: investor feelings

Market timers also look at investor sentiment. The more investors are optimistic and ready to buy, the more the market is likely to fall and vice versa.

Indicators used: resistance level and support level

When looking at a stock's price history chart, you will notice that after the price of a stock reaches a certain level, it usually goes down (the resistance level), and when it reaches a certain floor (its support level), it will climb back up. An investor who uses market timing will try to buy as close to the support level as possible and sell near the stock's resistance level.

When buy and sell indicators occur near each other, the phenomenon is called a whipsaw. A whipsaw indicates that investors are reversing themselves. This can make it difficult for investors to time their trades accurately, with potentially costly results.

Dive Deeper: Investment strategies 101: The full breakdown

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

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