I'm not sure why I'm bothering to respond again, but to the extent that it was a serious, non-market timing question, it does not work.
The title to this post was "Extremely risky market timing strategy to use to gamble w/ your 401," which seemed to focus on taking a large loan out of your 401(k) right before a market crash to then pump back into the market after the crash. That was all dependent on market timing, which is why the responses dealt with market timing.
As to the non-market timing issues, it doesn't work either.
First, you're taking the money as a loan from your 401(k), which means the money that you're taking out of the market to invest back in the market is just a wash. No additional money goes to the market from the loan.
Second, the money you pay back into your 401(k) as interest is post-tax money, but goes into the 401(k) account with your other pre-tax contributions. Thus, you're gaining no tax advantage from the additional dollars you're able to pay into the 401(k) as interest, and indeed, may end up paying greater taxes if the ordinary income tax rate at the time you pull the money out of the 401(k) is greater than the long-term capital gains rate you would have paid if you just put the after-tax dollars in a non-retirement investment account.
Third, you're not putting any additional money into the market through the interest payments because you could otherwise have just put those payments into a non-retirement market account.
I took out a loan from my 401(k) and shared the initial excitement in recognizing that the benefit of the loan is that you're paying all the interest back to yourself. But beyond that, there is no tax benefit or market benefit. Every dollar you took out as loan was already in the market, and every after-tax dollar you pay back as interest could have otherwise been invested in a non-retirement market account, so no gain there either.
Thus, there is no advantage to this approach other than the "market-timing" approach, which actually isn't a benefit either. Because you're taking the loan from your own market holdings, you could achieve the same goal by moving your money to a cash holding within your 401(k) until the market drop, then buy back into the market within the 401(k) "after the drop." The same is true for the "interest" you would have paid, because you just put those after-tax dollars in a non-retirement market account "after the drop." Of course, as stated above, I would not do this because market timing.
So, no loophole discovered. The benefit of borrowing against your 401(k) is that the "interest" you pay is all paid back to you, rather than a bank. The downside is that the money you borrow is not in the market so long as it's borrowed and being used for something other than market purposes.