Timing the Market With the 200 DMAs

I read yet another article yesterday that said the market cannot be timed. This is a good rule of thumb to be sure but it is not universal, and for anyone who is new, it might be worth giving one example of what has been a useful tool. I use this as a tipping point in the accounts I manage.

click to enlarge

The first chart is from the mid-1970s and the second chart is from early in this decade. The black line in both charts is the S&P 500 and the yellowish or brown line is the 200 DMA.

As you can see in both instances - and it is also true in the current market event - the 200 DMA was not breached at the top, but served to avoid most of the decline if adhered to in the strictest sense (which would be all in above and all out below).

If you look at the S&P with its 200 DMA over the last few years you will see several headfakes with this indicator, where it went below the 200 DMA for a few days before going back above. This would not matter to anyone with one ETF. A fake out that results in one or two extra $10 commissions is not a big problem.

However in the real world, where investors have diversified portfolios that would incur real commission expense and tax consequences, all in or all out becomes impractical. But it is the evidence in the two charts - how the current decline has played out provides further support - which leads me to use this indicator for taking the type of defensive action I have mentioned numerous times before.

Changing subjects, the Fed seems to have pulled a rabbit out of its hat yesterday with the TSLF news to help lube the bond market's chassis a bit, although some question what the real catalyst was. Despite my bearish expectations, I would be thrilled if the bottom was in and equity prices would stabilize with an upward bias (pretty much Emily Litella-izing yesterday's post). Bull markets make the job easier and more importantly makes it easier for clients.

You probably heard the comments from the various naysayers about the TSLF and unfortunately I probably side with them. There are still more writedowns to come. I can't see how earnings don't get further impacted. One reader forwarded a skeptical report from Merrill that cited the market is $6 trillion big and the TSLF is only $200 billion. Bear markets usually turn for no reason at all, not from a clear and obvious catalyst, and there are probably other things too.

One other aspect about this is that the Fed is clearly willing to take action that appears to be innovative. It has no qualms about doing something and then coming back very quickly with something else. While that could be a plus, it leaves me thinking that the Fed is reacting to news as it hits the tape instead of proactively trying to right the ship. If that is correct, then I don't take much solace from a Fed that is continually a step or two behind the music.

Here's hoping I am wrong.

Comments

[Scott Teresi]

How about some actual figures showing the risk level and annual return you would get from following this trading strategy? Technical analysis is often frustrating without any hard data to back up what people are saying, but this particular system is so simple you should be able to provide data that it works before you decided to use it!

[RogerNusbaum]

you can easily get the data from Yahoo finance but the charts are what they are.

[rickyrosenberg]

I give up: What is the "D" in DMA?

[Augustus]

I understand that the "charts are what they are." Except, if you are advocating this be used in practice, you should provide the data to show that it is effective over the entire period, not just for a couple of periods with large declines. Both charts seem to show many whipsaws that would have cost the investors money in the generally rising periods. Sure, some losses would have been avoided in the big declines. Are those larger or smaller than the whipsaw losses over the other periods? You might want to check that out before rushing to implement this - or recommending it.

[Indexor]

For Ricky: the "D" stands for "Day" as in 200-Day Moving Average instead of 200-Week Moving Average or 200-Month Moving Average.

For aaCharley: Mr. Nusbuam has provided two excellent "data" examples to back up his article. You may need to re-read these charts a little closer at stockcharts.com to realize the true benefit. Having used a similar strategy during the 2000-2002 Bear market, I can assure you that a substantial amount of money was saved by sitting in cash. And, this strategy can be utilized in other asset classes as well. Remember, this is investing where no strategy is an absolute. But using the 200-Day moving average, as Mr. Nusbaum has suggested, may provide you with another tool that can save your client's money in a down market, reduce their portfolio risk (Standard Deviation) substantially and increase their overall return.