Can you time the market?
Market timing systems based on the stock market’s 200-day moving average may have worked in the past but not so much in recent years.
Would you pay a few hundred dollars a year for a system that might have helped you dodge this month's stock market slide? Well, somebody sure is. At last count, there were roughly 180 newsletters in North America promising to do just that.
Trouble is, despite their innate appeal, many of these market-timing services have a rather poor track record.
In fact, the record of market timers offering advice for investors is so inconsistent that many fail to outperform either the market or the average diversified equity fund, reports Mark Hulbert, publisher of The Hulbert Financial Digest, which has been tracking investment newsletters for the past 30 years.
Factor in commission costs and taxes — something that, because they vary so sharply among investors, few timers bother to do when making performance claims — and the results look that much more suspect.
In other words, even the professionals have trouble riding out market turbulence.
Historically, the stock market makes dramatic moves in relatively short periods, and nervous investors who sell early effectively forgo a hefty portion of the possible gains.
However, as we've seen in recent weeks, the downward moves can also be quite sharp. That's why buy-and-hold investors can end up even worse off than the services that pursue market-timing strategies - even if the pros' published results may look rather lame statistically.
Is there any way to protect yourself? Try looking at the average of the market's closing prices for the last 200 trading sessions, suggest some analysts.
Doing this calculation for each day going backwards in time shows how that 200-day average has shifted - hence the term "200-day moving average."
Simply put, when an index like the S&P 500 is trading above its long-term moving average, hold on; but be prepared to quickly move to cash when it drops below that level.
Will this strategy shield you from a market rout? It certainly has in the past, maintains Sam Stovall, chief investment strategist at Standard & Poor's.
Stovall went back four decades to see how well you might have done if you'd used a 200-day and other moving average indicators as a "get-me-out-of-here" guide, rather than simply buying the index and holding on.
He considered several (50-, 65- or 200-day) moving averages, both singly and in pairs, looking for prime buying and selling points.
While the results were mixed for strategies that simply concentrated on the shorter-term moving averages, Stovall found that using the 200-day average, as well as some combinations, would have helped you hang on to more of your money.
While no one moving-average strategy was a surefire bet, several would have helped protect you from the worst market downturns while still allowing you to participate in most of the market rallies, he believes. You can read his detailed findings here.
"What really makes following a longer-term moving average system desirable, in my opinion, is that it forces you to stay in the market for as long as possible, but then gets out of the way before any real damage is done to your portfolio," Stovall reports.
"As a result, I believe the risk/return trade-off is that while you will likely underperform the market by a few percentage points each year, you can be fairly confident that you will be out of the market during the big declines."
Despite this, some argue that the 200-day moving average has actually lost much of the value it once had as a market timing indicator.
According to Mark Hulbert's data, a hypothetical moving-average portfolio has actually lagged a simple buy-and-hold approach over the past two decades, largely due to the strategy's increased popularity. And he doesn't see this changing anytime soon.
As more and more investors begin to follow a system, of course, its potential to beat the market begins to evaporate. In fact, because many mechanical trend-following strategists focus on this measure so closely, their interest may actually mean that more selling may yet hit the market.
The bottom line? While it has worked in the past, even over long stretches, you may want to think twice before buying or selling stocks based on whether the market is above or below its 200-day moving average, he warns.
MSN.ca Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.
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