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ETF Core Strategies

Aim: To trend-trade general equity ETFs so as to ride rallies and buck busts in the Australian share market.

ETF Rotation Strategies

Aim: To back the local and foreign sector ETFs with the strongest price gains over both short and long terms.

Why should I time the stock market?

Empirical Evidence

Modern market timing is an evidence based approach to managing equity market risk which stock and sector diversification does not address.

It should not be confused with traditional market pattern recognition (e.g. head and shoulder formations, Elliot waves, Dow theory, Fibonacci numbers, etc) which has mixed outcomes.

Market timing relies purely on reacting to any changes in the market’s direction and momentum instead of trying to forecast its trend using fundamental ratio analysis or chartist pattern recognition. It’s the only share market strategy grounded in reality rather than crystal ball gazing.

Modern market timing came of age with the advent of personal computers, powerful trading platforms and fast internet that allowed market enthusiasts to test and refine a wide range of technical indicators on both historic and live market data.

Reputable studies and market timing monitoring services show that quantitative models using widely accepted technical indicators work. Even crude moving average crossover strategies that don’t take account of market momentum and volume beat buy and hold consistently.

The leading advocate of buy and hold (Jeremy Siegel, Stocks for the Long Term) acknowledges that a simple 200 day moving average was superior to buy and hold on both returns and volatility from 1886 to 2006. He also admits that the long held contention in academic circles that the market can’t be gainfully timed is ‘cracking’ since econometric research has shown that simple trading rules can be used to improve returns.

Other researchers [William Gordon, Robert Colby, Ben Stein and Phil DeMuth, Leslie Masonson, Deborah Weir] have shown that buying and selling indexed stock market funds when their moving average unit price crosses over their daily price beats buying and holding them by a wide margin over the long term. Authors of technical indicator texts [Alexander Elder, Tom DeMark, Charles Kirkpatrick, Joe Duarte, Stan Weinstein, Justine Pollard, Martin Pring and Robert Pardo] have demonstrated that both risk and return on such funds can be improved further through using a combination of directional indicators, momentum oscillators and volume measures for timing the market.

TimerTrac which has monitored the performance of mechanical market timers (as distinct from share tipsters and technical chartists) on a daily basis for more than 10 years shows that 60% to 85% beat the S&P500 index on a consistent basis. The top 50% of timers do so by a large margin.

Back-testing

MarketTiming’s two strategies when back tested over the last 28 financial years show superior results to buy and hold in terms of both boosting returns (i.e. capital gains) and lowering risks (i.e. downside volatility).

For each strategy our historic results are impressive on a range of measures.

For instance simulation of our Conservative timing signals from 1 July 1984 to 30 June 2012 showed the following results: 

  • An average annualised return of +9.0% versus buy and hold’s +6.8%.
  • Of the 38 (enter-exit) trades over this period, 63% were winning ones.
  • The average gain on winning trades was +13.5%.
  • The average loss on losing trades was only -3.6%.
  • Of the 38 (exit-enter) trades in the market, 40% avoided losses suffered by buy and hold.
  • The average loss avoided while out of the market was -7.7%.
  • The average gain missed while out of the market was +3.94%.
  • The average drawdown (i.e. downside risk) for this market timing strategy was -4.9% versus -15.0% for a market buy and hold strategy.
  • In July 2012 MarketTiming upgraded the Conservative Strategy to better cope with a ranging market as occurred post 2009.The new Conservative Strategy when back-tested to mid-1984 produced improved results on the original strategy shown above. For instance the average annual gain would have been 9.8% (instead of 9.0%) and the proportion of winning enter/exit trades would have been 75% (versus 63%).

Of course past performance is not necessarily indicative of future performance. But when evaluating any new investment system an important consideration must be how it would have performed over an extended period covering both bull and bear markets.

Market neutral

Market timing works in both rising and falling markets unlike buy and hold which relies on the market being on a long-term upward trajectory. Stock markets since 1700 have been in a secular bear phase 47% of the time (1720-90, 1832-62, 1929-49, 1966-82 and 2000-?).

In terms of the real purchasing power of shares the bear phases have exceeded the bull phases. In the US, the post-2000 period for shareholders (as opposed to share traders and timers) have been worse than the 1930s. In Japan, the second largest economy, shares by March 2009 were worth 80% less than in 1990. Only good traders and timers avoided this wealth destruction.

There is no assurance the Australian share market will return to the extremely bullish conditions that predominated from 1982 to 2007. Even if it did it would still be subject to periodic corrections as the following table shows for the last 52 years. Note that there were 15 bear markets (happening on average once every 3½ years) with an average duration of about 10 months and an average fall in the All Ordinaries Index of almost one third from peak to trough.

Avoiding the worst of each bear market correction while enjoying the best of each share market advance is the appeal of reliable share market timing.

Bear Market Duration % Decline
Sep 60-Nov 60 2 months -23.2%
Feb 64-Jun 65 16 months -20.0%
Jan 70-Nov 71 22 months -39.0%
Jan 73-Sep 74 20 months -59.3%
Aug 76-Nov 76 3 months -22.0%
Feb 80-Mar 80 2 months -20.2%
Nov 80-Jul 82 20 months -40.6%
Sep 87-Nov 87 2 months -50.0%
Aug 89-Jan 91 15 months -32.4%
May 92-Nov92 6 months -20.3%
Feb 94-Feb 95 12 months -23.0%
Sep 97-Oct 97 1 month -21.0%
Mar 02-Mar 03 12 months -22.3%
Nov 07-Mar 09 16 months -54.6%
Apr 11-Sep 11 6 months -22.5%
Average 10.3 months -31.4%

For prudential reasons alone, investors who are unsettled by bear market falls averaging 31% every 3½ years should consider applying proven market timing principles (using exchange traded funds) to at least a portion of their equity holdings so as to manage market risk. Unlike specific stock risk, general market risk can’t be addressed by simply diversifying share holdings.

We of course don’t know your personal financial circumstances, needs and objectives so we can’t give you personal investment advice. See a financial planner for that. Our purpose is confined to providing market timing signals.

Objective guidance 

Investors, who have been burnt by a share crash often retreat from the market too afraid to re-enter it. Yet they know that over the long run shares give better returns than cash management trusts, fixed term deposits or fixed interest securities (e.g. bonds). 

Modern market timing offers bruised investors a way back into the share market by providing the comfort that it has an inbuilt mechanism for protecting capital in a stock market crash. Since timing is based on gauging the direction and momentum of the market it quickly alerts investors to leave the market when these indicators turn negative. 

Modern market timing is like a lifeguard who gives someone the confidence to go back into the surf after they have been dumped. They do this by assuring swimmers that they are watching the waves and will blow the whistle if conditions become dangerous. Swimmers only have to agree to one condition – to swim between the flags and not to take excessive risks. 

Market timing is similar. It expects adherents to heed signals on general market risk and to minimise specific company risk by using only managed funds that invest in 50 or more shares. 

Worrying about when to enter or leave the share market is not a concern for investors using a good market timing service since they are told when to act by email alerts. They sleep well at night knowing that their risk exposure to the overall share market is being independently and objectively monitored by a third party who will signal them to get out of the market when it looks dangerous and to return to it when it looks safe. 

The proponents of buy and hold forget how difficult it is for ordinary investors to stay in the share market regardless of its conditions. The experience is not dissimilar to a roller coaster ride. When the market is rising the ride is pleasant and as it gets to the top of the incline the general feeling is euphoric. But when it starts falling fear sets in and as the pace quickens panic ensues. That’s why so many investors enter at the top of the market when confidence is high, but exit at the bottom when no end seems in sight. 

It explains why, in the US, individuals earned only 2.6% per annum on shares between 1984 and 2002 even though the S&P500 gained 12.2% per annum [Dalbar, Inc. Quantitative Analysis of Investor Behaviour, July 2003 and quoted in John P. Reese, The Guru Investor, John Wiley & Sons, New Jersey, 2009, page xiv]. Too few investors had the stomach to sit out the journey through steep rises and falls in the index. Others had shorter term objectives so could not afford to stay the course. 

It’s the reason more and more investors are turning to market timing as they can’t stand the thrill of the roller coaster ride. Also those in or towards retirement don’t have the time to recover from a bad share market crash. Their aim is to protect their capital so they can fund their needs when they no longer have a salary. 

The next chart shows how MarketTiming’s Conservative Strategy would have applied since mid-2004. Notice how an investor would have been spared any significant market correction.

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