Can you time the stock market? Many professionals will say no. I say yes. But my “yes” comes with caveats. In this article, I will share with you a method I developed and regularly use, and has been “back tested” successfully for 100 years. It is a perfect method for the typical 401k investor, who doesn’t look at their portfolio very often. This method will move you into stock funds when the market is rising, and move you to the sidelines, in money market funds, when the market is declining. In so doing, your retirement funds can avoid the 50% drops in the stock market like we saw in 2000-2002, or from 2007-2009, where it take years to recoup your losses.
First, I don’t believe anyone can consistently time the market over short term periods, moving money in the market when it is expected to go higher, and moving money out when it is expected to go lower. “Day Trading” is a dangerous practice where a trader will move money in an out of the market on a daily basis, and I do not recommend it for anyone. “Swing trading” operates on the same principle, but you are trading over a period of weeks, instead of days. Similarly, swing trading doesn’t have a long history of success either. I do believe, however, the average person can successfully trade the longer term economic and stock cycles by using a couple simple indicators.
As you read, please reference the link below to a chart of the S&P 500 ETF (exchange traded fund) known as the “SPY”. The SPY is a security which mimics the action of the S&P 500 market index. I produced this chart using the Charles Schwab Streetsmart Edge software, but you can accomplish the same thing online using free charting tools from finance.yahoo.com. Just be sure you are looking at “monthly” settings for the S&P 500 (or the SPY).
This chart shows a long term, 20-year, MONTHLY picture of the SPY. The top section is a “candlestick” chart, where each vertical line, or candlestick, represents 1 month of trading activity. If the SPY had a lower price at the end of the month than it did at the start, the candlestick is red. If the SPY had a higher price at the end of the month than it did at the start, the candle stick is depicted in green. The height of the candlestick shows the range that the SPY moved during the month.
Below the chart I have displayed 2 technical indicators. One is called the “MACD” (Moving Average Convergence/Divergence), and the other is called the RSI (Relative Strength Index). I use standard/default settings for both indicators.
The MACD is a trend indicator that looks at the “moving average” of the stock/security price over a longer period and a shorter period. This produces two lines, and when the shorter period line “crosses over” the longer period line, it can signal a trend change. The indicator by itself is not perfect, and can provide false signals, especially if the market is volatile, changing direction frequently. The indicator is more stable with long term trends, such as what we are looking at here.
The RSI is another technical indicator known as a “momentum oscillator”. It evaluates the rate and magnitude of directional price movements. If a security is meeting with heavy, persistent, selling or buying, the RSI will fall or rise accordingly. I like to think of it as the “pressure” on the security to move in one direction or other other. The RSI typically moves in a range from 30 to 70, as shown on the chart. When the indicator is over 70, the security is considered to be “overbought”. When it is below 30, it is considered to be “oversold”. Just because the RSI is in “overbought” territory, that doesn’t mean it cannot stay there for months or years, and perhaps become more overbought. Similar with the oversold condition. Trading solely on this indicator could cause you to miss years of gains waiting for the market to change direction!
Stock investing involves two types of analysis. Fundamental analysis involves looking at the earnings of a company, and buying companies having consistent growth over a long period of time. If the stock can be purchased at a low price because of market fluctuations, all the better. In the long run, the price will adjust to earnings. Famous investors such as Warren Buffett and Benjamin Graham have used this method successfully.
Technical analysis doesn’t care about earnings. Technical analysts reason that there is only one thing that makes a stock go up or down, and that is investors either buying or selling the stock. A stock can have the greatest earnings in the world, but if investors are not buying the stock, the price will not move higher! So technical analysts looks at price movements and momentum indicators to see what investors are actually doing.
The best investors consider BOTH types of analysis. But a rule of thumb is that you can use fundamental analysis to tell you what to buy or sell, and use technical analysis to tell you when to buy or sell it.
Since I am making a case for “timing the market” on a long term basis, I rely on the technical indicators described above (the MACD and RSI) to help guide me.
This post is not about the details of all the types of indicators, as you can read about those online from numerous places, and I encourage you to do so. Knowledge of the markets can only help you.
Back to the Chart:
I utilize a combination of the two indicators (the MACD and RSI) to guide timing, in and out of the longer term market trends.
As a bull market continues (i.e. from 2003 thru 2007), you can see the RSI moves into overbought territory (above 70), and can stay there many months. At the same time, the MACD short term average line remains below the long term average line, only briefly crossing or touching. Eventually, the market starts to weaken, and you see the RSI pulling out of overbought territory AND the MACD does a clear “bearish” crossover. When BOTH indicators signal a change, then I move money from stock funds to money market funds (safe interest bearing funds). By doing so in the 2007 to 2009 period, I avoided a 50% loss in my retirement portfolio!
Then the opposite is true. The RSI goes to the other extreme, as does the MACD. I then watch for the RSI to move out of oversold territory (back above 30) and for the MACD to do a bullish crossover. When both indicators signal that bullish condition, I buy stock funds, and move money out of the “safe” money market funds.
If you notice in late 2011, the MACD did a bearish crossover, but the RSI was still rising towards the 70 level. When this happened, stocks were still a good value (fundamentally), and I only had 1 of the 2 indicators indicating a sell signal. Because it was only 1 indicator, I held on for the remainder of the bull market. What the MACD signaled was a short term “correction”.
In early 2015, I got a another sell signal, with the MACD and RSI confirming each other. Over the next year and a half, the market swooned downward by 10% on two separate occasions. A buy signal reappeared in September 2016, where I bought back at about the same level I sold. So I avoided all the volatility in the market. If the same performance can be had with less volatility, the option with lower volatility is considered the better investment.
Note also that they call the recent rally the “The Trump Bump”. The truth of the matter is that the market was beginning to flash a buy signal two months prior to Trump being elected. Investors were already reallocating funds to the market! It should be noted that politics does NOT control money. Instead, money controls politics! So regardless of who got elected, the market likely would have moved higher.
For a person unfamiliar with the markets, this article may seem a bit overwhelming. Hopefully, it acted as an introduction, and perked your interest to discover more.
The stock markets are what make commerce happen, and ultimately what makes your job happen, if you hold one. They are essential to the functioning of the economy. They can be your best friend, and can make you very very rich! To the uninformed, they can also take what little you have. There are no guarantees in a free economy.
As I stated, I have back-tested these indicators for 100 years, and they have been an accurate indicator for when to put money into the market, and when to take it out that entire time. This method beats a “buy & hold” strategy. Can it fail in the future? I suppose so, but for my lifetime, it seems to have served me well!