In the run-up to the Christmas season, prices of goods tend to increase. Once the Christmas season passes and the new year sets in, shops tend to sell the same products at a lower price. In this case, Christmas and the new year can influence the price of a product.
It’s all about the perception of time. January sales are to Christmas like market downturns are to investing, especially for long-term investors. In the case of the latter, there isn’t any prefined date. Nonetheless, one can observe the markets and programme “sales” of stocks and other commodities and enter the market cheaper.
In a January sale, the buyer’s objective is to buy the same product at a lower price.
Certain products like fashion items can become outdated when they go for sale. Other items like electronic equipment won’t. The same reasoning doesn’t apply to investing. Everything is in fashion. The only difference when investing is to invest a fixed amount of money and get more of the stocks or other commodities, e.g. Bitcoin, oil, gold, etc.
Sir Isaac Newton, a famous scientist, once said, “What goes up must come down!”. The same applies to investments. Unlike physics, not everything comes down the same. There are three primary ways to describe how markets “come down”.
The ranking of the stages below is from the least extreme to the most severe:
- Corrections are considered healthy as the prices of stocks of commodities increase. The prices of healthy investments usually go up, enter a correction period, and continue to increase. A correction occurs when a market index like the S&P500 and Nasdaq Composite declines more than 10% but less than 20% from their peak prices, i.e. the last highest price. Corrections can last between a few weeks and a few months.
- A more severe case of correction is a bear market. A bear market is when market indices decline more than 20% from their peak. These tend to be longer than corrections, as bear markets need to become a correction before they mature into one. Cryptocurrencies are pretty familiar with bear markets.
- A recession is the most severe of all three. Recessions are measured using official Government statistics like comparing economic growth, such as the Gross Domestic Product, to previous periods. Other official and indicative statistics include employment, inflation rates, industrial production, retail sales, etc. Recessions take longer than a bear market and can last months or years.
A correction can be a precursor to a bear market, and a bear market can be a precursor to a recession. One must keep in mind that one step may not lead to another.
The reasoning behind timing the market
Timing the market is when an investor follows the price charts of shares and commodities and invests their funds according to what they believe is the lowest price of the asset. The objective is to buy at the lowest price and sell at the highest price.
Warren Buffett and Elon Musk suggest that investors shouldn’t follow price charts. They advise investors to put their money into stocks and commodities regardless of the timing of the market. They believe that the value of the shares should increase in the long run.
Up to a certain point, they’re right. One should invest for the longer term instead of getting in and out of the market. Studies suggest that people who invested for the long-term made higher returns than short-term traders.
Everyone makes money when the market goes well. However, this strategy is only beneficial during bull markets. Bull markets are when the prices of assets increase. The situation can be highly demoralising for new investors to buy an asset at a high price only to lose its value during a correction or a bear market.
Why should you buy something at a high price now when you can buy it cheaper in a few weeks or months? Timing helps you get more for less.
You can never guess the exact bottom of the market. Markets can continue going lower—nonetheless, the better the timing, the better the value of money for your investment.
Timing the market requires one to follow financial news closely. Since not everyone has the time to do so, timing the market might not be a good strategy.
Dollar-cost averaging strategy (Beginners)
Dollar-cost averaging is a common strategy. An investor divides their investing capital equally over a specified period, like a year and invests the same proportion.
For example, if you have $1,200. You may decide to invest $100 every month over a year. Using this strategy, you will discard what’s happening in the market. While this might not be that profitable such as timing the markets, the dollar-cost average strategy is more profitable than short-term investing.
Dollar-cost averaging strategy is suitable for novice investors or people who don’t have the time to follow what’s happening daily in the financial markets.
Timing the market strategy (advanced)
Advanced investors have the time and resources to try and predict peaks (high prices) and troughs (lowest prices) of stocks, commodities and indices.
Investors who time the market tend to follow Warren Buffet’s maxim of being “fearful when others are greedy, and greedy when others are fearful.” Investors accumulate positions during bear markets as retail clients (individual investors) sell their investments at a loss. On the other hand, institutional investors (stockbrokers, investment firms, etc.) buy them from retail investors at a “discounted price”.
For example, during the 2008 recession, the S&P 500 index opened at 1,447.16 and closed at an index value of 903.25. If you invested $1,000 at the start of 2008, you would have lost 38% of your investment, or $380.
In 2009, the year after the recession, if you’ve invested $1,000 in the S&P, you could have made 23% in profit, or $230.
In most cases, a year of negative returns on the S&P 500 gives a higher rate of return in the following year.
The greed and fear index is one of many measuring market sentiment indicators. The greed-fear index is mainly associated with the crypto markets. However, the index exists for market indices, precious metals, etc.
Every commodity index uses different data points. For example, the one below is for Bitcoin. It uses volatility, market volume, social media, surveys, dominance and trends.
There may be different indices for the same asset. The difference would lie in the number, type, or weightings associated with the same data points.
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