Whenever the markets show weakness, “tactical traders” are featured on various financial programs discussing the opportunities of successfully timing the markets and avoiding downdrafts.
One story told by the tactical advisor might sound like:
“From 1998 to 2017, $10,000 invested in the S&P500 index would have grown to $40,135. A market timer that missed the 20 days with the biggest losses would have seen their $10,000 grow to $142,997. Missing just 0.4% of the trading days (20 of the 5,036 in that period) increased returns from 7.2% to 14.2%. This is the reason that it’s important to time the market.”
Of course, the “buy and hold” advisor tells a different story:
“From 1998 to 2017, $10,000 invested in the S&P500 index would have grown to $40,135. A market timer that missed the 20 days with the biggest gains would have seen their $10,000 grow to only $12,570. Missing just 0.4% of the trading days (20 of the 5,036 in that period), cuts returns from 7.2% to 1.2%. This is the reason not to time the market.”
Neither of these stories is fair.
I recently came upon the following chart (from Vanguard) showing daily returns of the stock market for the last 37 years and highlighting the best/worst trading days:
This chart shows several interesting things:
- The best and worst trading days are unusual; they are true outliers.
- Despite the media headlines, we have not seen any of the really volatile days in quite a while.
- The worst and best trading days often happen close to each other. (Notice how the blue lines in the chart are often very close to the red lines.) This shows how impossible it is to get all of the good without the bad or vice versa.
- Twelve out of the 20 best trading days occurred in years with negative annual returns. Great days do not necessarily make for a great year.
- Nine out of the 20 worst trading days occurred in years with positive annual returns. Bad days do not necessarily make for a bad year.
Over time, 54% of market days are positive and 46% are negative. This means guessing the direction of any one day’s market performance is close to the odds of predicting the results of a coin flip.
Getting the best/worst days correct is more like calling when a flipped coin will be landing on its edge.