Investing and market timing. Should you always stay in the market?

Recently I came across such an article.

Why market timing doesn’t work: S&P 500 is up 14% this year, but just 8 days explain the gains

The main idea is very simple — always be in the market. Don’t try to use timing. I can’t refrain from commenting on such manipulation of facts. Let’s test the claim about better days. I’ve used the SPY data since 2001. If we exclude the 5 best days, we will get the following results

BENCHMARK (SPY)
Annual Return  5.494185282437991
DrawDown  -56.47367075664624
Sharpe Ratio  0.3719859938744733
Volatility  0.1949605984029262
STRATEGY (exclude 5 best days)
Annual Return  3.2709984743259035
DrawDown  -65.9690038166293
Sharpe Ratio  0.2655253303454235
Volatility  0.188632525849103

It seems that the author is indeed correct - excluding just the 5 best days in 20 years reduces profit by 40%.

However, when we are out of the market we are just as likely to avoid the 5 worst days. So, let’s test it too.

BENCHMARK (SPY)
Annual Return  5.494185282437991
DrawDown  -56.47367075664624
Sharpe Ratio  0.3719859938744733
Volatility  0.1949605984029262
STRATEGY (exclude 5 worts days)
Annual Return  7.813709636823973
DrawDown  -43.377075328064905
Sharpe Ratio  0.4911535240247553
Volatility  0.18980107988576403

Yes, our assumption has proven to be correct — excluding the 5 worst days increases profit by more than 40%.

In the end let’s just exclude the best and worst days together

I can hardly see the difference.

So, if you are always in the market you will not miss the best days of growth but also you will not miss the worst days.

As for me, I focus on market timing. I’ll show you the results of a fairly simple system with a couple of indicators. These indicators tell us — to be in the market / out of the market.

BENCHMARK
Annual Return  5.494185282437991
DrawDown  -56.47367075664624
Sharpe Ratio  0.3719859938744733
Volatility  0.1949605984029262
STRATEGY
Annual Return  5.352256647642162
DrawDown  -27.159112105950328
Sharpe Ratio  0.4692956298909415
Volatility  0.12883119867779805

We observe that this strategy demonstrates the same profitability despite experiencing only half the drawdown (56% vs 27%). It enabled us to stay out of the market during the most significant downturns in 2001, 2009, and 2020. Please also note that now the strategy also recommends staying out of the market.

My current long-term model (it is more complex) gave a signal to exit the market in September 2021. It still maintains a bearish view. Nevertheless, I occasionally engage in the market when the two other models (short-term and mid-term) indicate a bullish outlook. However, going against the main trend is always very risky. Market timing is key.