The following is a true story, but unfortunately, it is not unique.

On Oct. 10, 2008, a friend of mine sold all his 401(k) stock funds and fled to the safety of cash. The reason? In an already reeling market, the Dow had fallen more than 2,000 points (or 22%) in slightly more than a week!

That was a Friday. On the following Monday, the market slapped him in the face. The Dow jumped 11%. Because of one day's fear, he had effectively added a year to his future retirement age.

He was then left with the uncomfortable choice of:

a) Putting his money back into the market, and risking losing that 11% a second time, or
b) Keeping his money in cash and missing out on a potential rally.

This is only the latest object lesson in why market timing is an excruciatingly dangerous game.

But it's a lucrative game ...
Now, I know what you're thinking. The market kept going down from there. After that 11% jump, the Dow fell from just less than 9,400 to 6,600 by early March. Staying in cash would have kept my friend (or any of us) from losing another 30%.

And let's not forget about the upside. Timing the market accurately can lead to amazing gains in very short periods to time -- and stock selection becomes secondary. Any idiot could have picked a stock on March 9th (the market bottom) and posted a gain ... regardless of a company's industry or relative health:


Two-second description

Gain since March 9, 2009


Highly leveraged casino


Dot com superstar


UnitedHealth Group (NYSE:UNH)

Major health insurer


ExxonMobil (NYSE:XOM)

Big oil



Satellite radio


Citigroup (NYSE:C)

Bailed-out bank


Johnson & Johnson (NYSE:JNJ)

Consumer staples blue chip


Source: Yahoo! Finance.

My friend had company
I said earlier that my friend's market timing debacle was true, but not unique. Recall that a few days prior to my friend's sell, Jim Cramer went on the Today show and made a bearish market call that he later bragged was the call of his life.

It's true that listening to Cramer could have saved you a fortune -- but only if you timed your reentry well. Otherwise, you would have broken even, less transaction costs and tax effects. After all, the market's right back where it was when Cramer made the call.

It's hard to speculate how many people followed Cramer's advice, and how successful they were at timing the market. But we do have some idea what individual investors as a group did during that time.

According to the Investment Company Institute, investors yanked $205 billion out of stock-based mutual funds during the half-year plunge ending in March. In the first five months of the rally thereafter, only a quarter of that was reinvested.

In other words, individual investors fled to cash near the bottom, then waited for times to get better before getting back in.

That's the worst market timing there is. In fact, it's a very effective formula for losing to the market.  

You aren't different
Now, you may think you're different from the average investor. Maybe you think you have a foolproof method for timing the market. But if you think you can cash out at the market top, and then get back in at the market bottom, well, you're fooling yourself.

Jack Bogle, founder of Vanguard, put it this way:

After nearly fifty years in this business, I do not know of anybody who has done it successfully and consistently. I don't even know anybody who knows anybody who has done it successfully and consistently.

In other words, trying to time the market is a loser's game. But that doesn't mean you can't take advantage of the market's swings.

Stay with "lucrative"
There are three reasonable ways to profit from market volatility:

  1. Investing consistently at regular intervals
  2. Rotating out overpriced winners with underpriced future winners
  3. Holding dry powder for opportunistic bargains

Simply putting money into the market at regular intervals allows you to smooth out the highs and lows of the market. Sometimes you'll get in near the bottom, sometimes you'll get in near the top, but you'll be in -- and that's the most important criterion for profiting. It's not sexy, but it makes the most sense for most investors.

For those who want a little more action, it's helpful to remember that individual stocks, though influenced heavily by the general state of the market, do not move in lockstep. Some stocks are way overpriced in a bottoming market, and some are bargains in a frothy market. By vigilantly looking for mispricings in your owned and watchlist stocks, you can take advantage in volatile markets.

Some investors (me included) like to take things a step further by keeping some dry powder (i.e. cash) around. By keeping a portion of their long-term portfolios in cash, they have the ability to load up on cheap stocks in favorable market situations.

It's not time to time
Trying to time the market is a self-defeating endeavor, so don't be fooled by the stories your friends tell you. They may have gotten lucky once or twice, but over the long haul, market timing is a recipe for subpar returns. And that's before the transaction costs and taxes. Nope, whether you're in index funds or individual stocks, it's best to take one of the three steady approaches I've outlined above.

At the Fool, we're putting our money where our mouth is. In our Million Dollar Portfolio service, we invest the Fool's own money in the best stocks we can find -- and at excellent prices, no matter what the market as a whole is doing.

If you want to learn more -- and find out how you can join -- just put your email in the box below.

Anand Chokkavelu owns shares of Citigroup and Sirius. He tried to time the market on a couple of occasions, but quickly realized he was a lousy, two-timing, small-f fool. and UnitedHealth Group are Motley Fool Stock Advisor recommendations. UnitedHealth Group is an Inside Value pick. Johnson & Johnson is an Income Investor selection. The Fool owns shares of UnitedHealth Group. The Fool has a disclosure policy.