A Simple Method for Market Timing

I’ve been thinking more and more about the historic decline we’re living through, and I think this will become a litmus test for investment advisors and money managers in the years ahead. The most popular question will be, “How did you perform during the 2007-2009 bear market?”

The advisors who fared poorly will likely struggle to get new clients or hold on to their current ones, and hence, may have trouble surviving. But the advisors that avoided most of the bear market and didn’t fall prey to the classic “you must remain fully I invested at all times!” mantra should thrive in the years ahead.

The real question you should be asking yourself if you’ve lost big money during the past year or two is, “How can I avoid this from ever happening to me again?” One answer, of course, is to swear off the market for good … put all your money in CDs and money-market funds. But I certainly advise against that–my guess is that, during the next 10 years, there are going to be huge, huge money-making opportunities, as today’s depressed levels will lead to a big bull market sometime down the road.

No, what you want is to avoid the meat of these nasty bear markets, but also profit from the following bull market. You can do it. And it doesn’t take a far seeing eye or a deep understanding of the credit markets. All it takes is the discipline to follow the market’s trend.

That’s my biggest piece of advice for you: Dedicate yourself to adhering to a trend-following market timing system. It’s not as sexy as forecasting what will happen down the road but it will be more profitable!

My suggestion is to get familiar with charts (there are many free charting programs online) and take five minutes to look at some of the major indexes every day or two. On the chart, you want to plot the index itself (say, the S&P 500), and you also want to plot its 50-day moving average. If most indexes are above their 50-day line, you should be constructive toward stocks. If most are below, you should be defensive. It sounds simple … and it is.

But such a simple system has many advantages, the biggest of which is powerful–by following the market’s trend, you’re guaranteed (that’s right–guaranteed) never to miss out on a major market upmove, nor will you ever stay heavily invested during a punishing downmove. How? Because if the indexes head south for any period of time, it will break through its 50-day moving average … and force you to turn defensive. The opposite is true for a market advance.

What’s the downside? You will be subject to the occasional whipsaw–a new buy signal, for instance, could be reversed a couple of weeks later. And that will require you to be willing to quickly change your stance. These whipsaws can be frustrating, but in the long run, they’re a small price to pay for being in (or out of) the big moves in the market.

Comments

[AlphaDude:]

Yup, this investing stuff is so easy :)

Mar 09 05:09 PM

[J. D. Swampfox:]

I agree that watching the 50 day (particularly, along with the 200 day) is "useful" but I have found no "mechanical" rules for using this measure -yet. However, momentum trading is documented to yield higher returns than buy and hold.
See, for example: papers.ssrn.com/sol3/p...

Mar 09 05:18 PM

[Fred Voetsch:]

Excellent advice. Most people are way too reluctant to accept a new trend and using a specific tool, such as the 50-day-moving-average, will force a bit of discipline on them.

Mar 09 05:19 PM

[andrew c:]

If you use the 20- and 50-week simple moving averages (20 crosses above the 50, buy, 20 cross below the 50, sell) for signals on the S&P, you essentially get the same returns as the S&P, BUT with less "beta" (risk).

I'd advise it for anybody nearing retirement... you don't want lots of risk at that point in life.

This method signaled a "sell" in mid-January 2008, and would've kept people out of the market through all the carnage of 2008 & 2009.

If you're 20 or 30 or even 40 years old, you're still probably better off with buy & hold... it performs marginally better, but over 20-50 years, that makes it worth the extra risk.

I don't know of any other "sure-fire" moving-average indicators.

If making money in the markets were easy, there wouldn't be a loser for every winner.

Mar 09 05:29 PM

[mplaut:]

This link will get you the DJI with the 50 and 200 day moving averages:

finance.yahoo.com/echa...=^DJI#chart2:symbol=^d...

Mar 09 06:19 PM

[mplaut:]

Trying again (breaking it all up - you have to put everything together without spaces or line breaks):

finance.yahoo.com

/echarts?s=^DJI#chart2...

indicator=sma(50,200)+...

ohlcvalues=0;logscale=...

Mar 09 06:21 PM

[Bruce Pile:]

The moving average rule you describe is indeed the best way to "time" the market. I like the word "identify" rather than "time" because there are always large investable moves taking place to be found and they have a strong tendency to stay on top of a moving average most of the way. The 100 dma is more useful for this because most large climbs have enough volatility to chase you in and out of a stock or index many times if you sell and buy back every time the 50 dma is breached and regained. Worthwhile climbs tend to stay on top of their 100 dma and end when they trade below it for a few days.

An effective strategy I have used is simply this: Use good selection criteria (cash flow characteristics, valuation, etc.) then select a good technical entry point at or near a 50/200 or 100/200 cross and hold as long as it stays on top of a rising 100. If it trades below the 100, replace it with one that is staying on top of its rising 100. Think about it, if you do this religiously and don't stubbornly hang onto a stock because you feel the market isn't being fair, every single component of a portfolio is climbing above a rising 100 dma and thus the whole portfolio stays climbing on top of a rising 100 dma!

If the market is so bad that you can't find much above it's 100, then, after taking some losses as most things break down below the 100, you're in cash or defensive things and don't suffer as much damage as the broad market. So this method has a stop out effect without you having to nervously jump in and out en masse trying to "time" the market every time there is a viable threat. When isn't there a viable threat? This approach keeps you running circles around the market in between the market drops that actually materialize but keeps damage limited at each drop (good long-term alpha).

Mar 09 09:38 PM

[Andrew S:]

As bad as this downturn has been for some people, it is very interesting and entertaining to see how/if the various pundits change their tunes.

It always amazes me how long it takes some of these folks to admit their mistakes and move on.

I like the idea of using a technical measure like charts to make decisions because of the objectiveness of it. I have never used it myself but you have peaked my interest. I have always been the researching type. I think a combination of the two might work out best.

Thanks for the article,

Andrew
IntelligentBuyer.com

Mar 09 09:59 PM

[sr9web:]

The best way to "time" the market is to never, ever sell any shares except on the 3rd or later "up" day in a row for the market. Sometimes runs go 4-5+ days up in a row, but 3 days minimum is a good rule. So, when a big "up" day comes, wait for the 2nd and 3rd follow through days, if 3rd day is up, if you want to sell, sell. Reverse the process to buy. No matter what DO NOT BUY any shares unless the market has been down a minimum of 3 days in a row, with one of those a hard "down" day. Stick to this rule no matter what, no matter how scary it gets and you'll come out ahead over time.

Mar 10 02:35 AM

[Guru914:]

There's been much written about the value and "accuracy" of the 200-day moving average as a market timing tool in my blog (stockchartist.blogspot... - search the blog on the term) and elsewhere.

Mar 10 06:54 AM

[Dave Shafer:]

Wow, a simple trend following formula that will make you money? Did you back test this? Would have been helpful. One question, everyone that does trend following states that they have large drawdowns at times. How do you account for this or do you claim your system will not?

Mar 10 08:55 AM

[Augustus:]

I would very much see the data you developed showing that your recommended method of market timing with the 50 dma is a market beating system. Or that it even performed as well as the market. Show the work from, say, 1920 through 2007. My guess is that it trailed very badly due to whipsaws. And then even when you go foreward to this current carnage you will still be behind, hoping to get back in before the rally leaves you behind.

Mar 10 01:58 PM