Effective market timing doesn’t require a supercomputer. All you need is a pencil, paper and a pocket calculator – and the discipline to record the price of a fund every day.

The market timing studies we describe in the accompanying article were all done with what’s known as a Simple Moving Average (SMA) timing system. Anybody can use this system to try to be out of an investment when it is falling and to get back in when it’s rising.

First, a few disclaimers. There is no magic here. This system does not strive to identify market tops and bottoms, so in that sense it will never “work” perfectly. It will make mistakes, and in any given week, month or year it may underperform a buy-and-hold approach. In addition, the system makes “mistakes” that generate short-term losses that buy-and-hold investors would avoid. There’s no guarantee that it will work in the future as it has worked in the past. Finally, timing is an emotionally challenging approach that many investors simply won’t follow.

In our study, we compared calendar year returns of the Standard & Poor’s 500 Index with and without this timing system in 59 years, from 1942 through 2000.

In 35 of those years, buy-and-hold outperformed timing. In 15 years, timing outperformed buy-and-hold. In the other nine years, the returns were the same, because the timing system remained fully invested all year.

Sometimes timing required enormous patience. This timing system produced a 12 percentage-point advantage in 1946, then didn’t outperform buy-and-hold until 1957. It takes a lot of faith to stick with timing through a period like that.

With all those limitations, why would anybody use such a system? Because, as you can see from the results in the studies we describe elsewhere in this issue, this timing system almost invariably would have improved the results that long-term stock investors experienced over the past 60 years.

The reason for timing’s superior performance is simple: In a relatively small number of years, the S&P 500 Index sustained large losses that this timing system either mitigated or avoided altogether.

In 12 years, the index without timing lost money; the average loss was 9.6 percent. In eight years, timing lost money; the average loss was 4.0 percent.

In seven years, timing was profitable while the index lost money. A dramatic example occurred in 1974, when the S&P 500 Index lost 26.7 percent; that year, timing made 9.7 percent.

Now let’s look under the hood at this system. It’s based on a simple 200-day moving average of the price of whatever fund you are timing. Using the system requires two steps.

The first step is the calculation, which you do every business day. If you’re using a big sheet of paper or a computer spreadsheet, simply record the closing price of the fund for each of the last 200 business days. Add up all the prices and divide by 200. That is the average. Because it’s a “moving” average, it changes daily. Every day, remove the oldest price and replace it with the newest one.

The second step is trading. If the price of the fund is higher than the moving average, you should be in the fund. If the price of the fund is lower than the average, you should be on the sidelines, in cash. So, to execute this strategy, buy or sell whenever the price of the fund changes its position relative to the moving average.

Calculating this by hand is tedious at best. But there’s a better way. Go to www.bigcharts.com. Type in the ticker symbol of the fund you want to track. (If you don’t know the symbol, type in the name. If you have trouble finding the ticker symbol on this site, try www.morningstar.com.)

Then click the button labeled “Interactive Charting.” On the left side of the resulting page, click the box labeled “time frame.” Use the drop-down boxes to select “3 months” and “Daily.” Then click the box marked “indicators” and under “Moving Averages,” select SMA and type 200 in the box next to that. Then click the red box labeled “Draw Chart.” (This is easier than it sounds.)

You’ll then see a chart for the fund price along with the moving average. You can experiment with different time periods and different lengths for the moving average.

You probably won’t have to trade very often with this system, as it’s designed to react only to large trends, not minor blips. Over the past 59 years with an S&P 500 Index fund, this system would have generated about six trades per year, on average.

If you own several funds, you may wish to compare each one of them to its moving average. We recommend caution in actually trading your funds based on this timing system, because every fund is different. If you have mutual funds inside a 401(k) and you can trade without commissions or tax consequences, you might consider using this system to time half the money you have in a particular fund, while you leave the other half committed on a buy-and-hold basis.

There’s no guarantee that you will increase your returns by doing that, but you might. And this system will reduce your risk by having half your money out of the market at least some of the time.

Critics of market timing often say that you have to be right 70 percent of the time for market timing to work. But I think our study shows just the opposite.

In the 59 years we studied, this rudimentary timing system generated 168 “round trips,” or buy signals followed by sell signals. You can think of a round trip as a temporary investment. Nearly two-thirds of those round trips resulted in losses. Only 36 percent of the round trips were profitable, yet over long periods, timing beat buy-and-hold in almost every case.

This “magic” occurred for a simple reason: The size of the wins vs. the size of the losses. The average loss of the losing round trips was only 0.8 percent. The average profit in the other trades was 14 percent. Yes, timing took a lot of backward steps. But they were tiny steps. Though fewer, the forward steps were huge by comparison.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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