The belief that one can identify, in advance, the optimal times to enter and exit the market is one of the most persistent and most thoroughly refuted ideas in finance. Its persistence in the face of overwhelming evidence to the contrary is a testament to the power of the psychological needs it serves—the need for control in an inherently uncertain environment, the need for a narrative of skill in an activity where outcomes are heavily influenced by chance, and the need for a sense of active participation in the management of one's financial future. These are legitimate psychological needs. They are simply needs that market timing cannot genuinely meet, because the ability to predict market timing is not, for most investors, a real ability.
The distinction between the experience of predicting market movements and the ability to do so is crucial. The investor who correctly predicted the market decline of any given year has a vivid memory of having done so, because correct predictions are emotionally salient. She tends not to have an equally vivid memory of the predictions that proved wrong, because incorrect predictions are more easily rationalised, forgotten, or reframed as approximately correct. The resulting impression of her own predictive ability is systematically biased upward. If she were to review a complete record of her market timing predictions against subsequent outcomes, the picture would typically look very different from the one her selective memory presents.
The professional forecasting record provides a useful calibration. Studies of equity market strategists at major financial institutions—people whose explicit job is to forecast market direction and who are supported by teams of analysts, proprietary data, and decades of institutional experience—show that their aggregate predictions are essentially uncorrelated with subsequent market outcomes over horizons of twelve months or less. If these professionals, with all of their resources and institutional support, cannot reliably predict market direction over a year, the individual investor who believes she can do so on the basis of her reading and intuition is operating under a significant misapprehension about the nature of the task.
What is actually happening when an investor believes she is timing the market successfully is typically one of three things. She may be confusing the expression of a sentiment with a genuine prediction—being broadly negative about markets during a period that subsequently declines is not the same as having specifically positioned her portfolio to profit from the decline. She may be experiencing the outcome of a decision that was fundamentally about something other than timing—buying equities when they were cheap and selling when they were expensive, which is valuation-based investing rather than market timing. Or she may simply be experiencing a run of luck that feels like skill because of the narrative she has constructed around it, and that will not persist over a large enough sample to distinguish it from chance.
The investor who accepts this—who genuinely believes that she cannot predict the market's short-term direction reliably—is freed from a significant source of portfolio mismanagement. She stops moving in and out of positions based on macro views that are not more reliable than consensus. She stops holding cash in anticipation of corrections that may or may not materialise. She stops selling good businesses because the market feels expensive to her, and stops buying mediocre ones because the market feels cheap. She invests in businesses she understands, at prices she believes offer adequate prospective return, and holds them until the thesis changes rather than until her market view changes.