Market Timing Strategies

As stated in a previous post I will be adding various market timing strategies to this site. I do not think one market timing strategy or one type of system will work in all markets, all the time. For this reason I plan to add market timing systems and strategies in the following categories:

Trend Following System– These Systems will embrace the existing trend of the market and not attempt to predict it.

Interest Rate Model – Is the current interest rate environment favorable to business?

Market Breadth – How broad based is the current move? Are only a few issues leading the market?

Market Sentiment – This is a measure of market or crowd psychology. When these measures reach extremes the market is likely to turn.

Seasonality – Some times of year are better than others to be in the market.

Market Fundamentals – Reference to these numbers will let you know if the market is priced high or low relative to history.

It is my hope that by using multiple systems from these categories we will avoid the risk of betting on one system that may breakdown at certain times.

Stock Market Timing vs Buy and Hold

There is a lot of talk these days about what makes more sense, a buy and hold investment strategy or stock market timing strategy?

Considering the stock market performance over the past ten years, I think the discussion is perfectly reasonable. How smart is it to buy something and forget about it. Is it reasonable to think we can predict what the market, a industry, or a business will look like in ten or twenty years. I think most people, when pressed to really think about it, would realize the absurdity of trying to predict what will happen to a stock in ten years. If you don’t believe me ask anyone who was holding Enron, Worldcom, Fannie Mae, GM, Citigroup or even GE long term.

Wikipedia defines market timing as “the strategy of making buy or sell decisions of financial assets (often stocks) by attempting to predict future market price movements. The prediction may be based on an outlook of market or economic conditions resulting from technical or fundamental analysis.” One of the primary differences between buy and hold and a market timing strategy is the time frame we are trying to predict. A buy and hold strategy by its definition has a much longer time frame than a market timing strategy typically would. A market timing strategy, makes its buy and sell decisions based on changes in the underlying technical indicators or the fundamentals of the market. The time frame of a market timing call based on technical analysis would rarely try to predict what the market is going to do much more than a year out. The farther out we try to predict, the less reliable the prediction. For example it would be relatively easy to predict that a team that makes the NBA finals one year would make the playoff the following year. If you tried to predict who would make the playoffs in ten years, your prediction would probably not be as reliable.

I believe that trying to call the tops and bottoms in the stock market is something best left to day traders and Wall Street professionals. So what about the rest of us? Those of us that would like to retire comfortably without being exposed to market gyrations we have witnessed in the last year. In upcoming post I will be introducing you to market timing models that will help you get better risk adjusted returns than a buy and hold strategy. I hope to do this in a fashion that will not require you to be glued to the markets every move. Most people do not have the time or the inclination to watch the market on a daily basis. That is where I plan to fill the gap by letting you live your life while I keep you updated on changes in the market that require your attention.

Even though I do not try to predict market tops and bottoms, I find myself placed in the realm of market timers. What I do try to do is find times when the risk of being in the market is high and reducing my exposure or tightening my stops. I also look for times when based on historical precedent risk is low and exposure to the market should be increased. I do not want to fight the trend or predict a change in trend. So it is with a certain amount of discomfort that I will sometimes refer to myself as a market timer.

Timing the Market with Best Six Month System

I will be adding trading systems to the site over time. In time I will have several intermediate to long term trading systems that I will follow. I will be following only systems that give fewer than 8 signals per year. Some fund companies limit the number of times you can move into and out of a fund. I do not want the signals given to be constrained by these fund-switching limits. Before you get started be sure you know the limitations and or cost associated with switching funds in your account. Personally I will be using these systems in my 401k accounts and my rollover accounts.

In this post I am adding the “Best Six Months with MACD” strategy. This strategy is covered every year in Stock Traders Almanac written by Jeffrey and Yale Hirsch (http://www.stocktradersalmanac.com). Sy Harding in his book, Riding the Bear, added the MACD indicator to the original “Best Six Months” strategy. He referred to this modified system as the “best mechanical system ever.”

How it Works

The original Best Six Months strategy is quite simple. Buy on November 1 and Sell on May 1. The Best Six Months with MACD is a little different. The dates are adjusted to October 16 and April 20. Two different MACD’s are applied, one for buy signals and one for sell signals. If the buy MACD differential is positive on October 16 we will go long. If the buy MACD differential is negative we will wait for it to turn positive before we go long. When April 20 arrives we will use the sell MACD differential to time our exit. If the sell MACD differential is negative we will sell on April 20. If it is positive we will stay long until it turns negative and then exit our long. I have not gone into a lot of detail regarding what is MACD or its differential? There are plenty of websites that go into greater depth of technical indicators. Check out http://stockcharts.com/school/ for in depth explanation of various technical indicators.

This system just gave its exit long signal on April 21, 2009. The system was down about 15% on the DJIA and down about 13% on the SPY this season. Although this system is far from perfect it was not long during the meltdown that occurred in September and early October 2008.

SPY CHART W/ BEST 6 MONTH SYSTEM

The Uptick Rule

In an effort to finally get off my ass. I am just going to start posting to the website. It is my sincere hope that you can do better with my trading signals than I am. I have a tendency to over analyze my own trading signals and it usually ends up costing me money. Case in point I managed to buy the SSO (Proshares Ultra S&P 500 ETF) on March 4, 2009.  Unfortunately, anticipating a pullback,  I sold some of my position on March 13.  I am still waiting for that pullback. I refuse to chase this market higher.

If you would like to see something interesting look at this chart.

SPY CHART W/ KEY UPTICK DATES

On July 6, 2007 The SEC abolished the Uptick Rule. The Uptick Rule said essentially you could only sell a stock short if the last tick was an uptick. This would make it difficult to sell a stock short into a falling market. The stock market peaked only 3% above the close of July 6, 2007.

On March 10, 2009 the SEC announced they were considering the reinstatement of the Uptick Rule, and the market has risen 19% from the close that day.

It would be impossible to determine how much of the stock market decline can be attributed to the abolishment of the Uptick Rule. My personal feeling is when the SEC abolished the Uptick Rule the short sellers started foaming at the mouth. As soon as the market started going in their direction, they started shorting anything and everything exasperating the move. The volatility in the market last fall is something I have not seen in 20 years of trading. Frankly I hope I never have to see it again. Sure somebody made money and some will find a way to justify all that happened. But when the stability of the foundation that holds the market together comes into question, enough is enough.

Please do not misunderstand me. I am not saying that the market decline was brought on by the abolishment of the uptick rule. That was started by the bursting of the housing bubble. What I am saying is the SEC’s timing could not have been worse. I also believe that the abolishment was directly responsible for the extreme volatility we witnessed.