Jump In! Jump Out! Using Market Timing

• Buy when you have money to invest.
• Sell when declines in the market cause you more pain than you want to tolerate.

Most investors can handle relatively small losses. For many, however, their viewpoint will shift as their losses mount, especially as they rise past the 15% level. As your losses get bigger, your fear of further losses grows exponentially. Eventually, this leads you to finally sell, with the hope that things will be different the next time you venture into the fray.

Market timing makes much more sense than buy-and-hold investing. Using market timing, you can accept small losses with relative ease. No one likes to lose money, but taking small, periodic losses will not cause you to give up on investing. If you use market timing, your money is never idle. Even when you're out of the market, you will invest your assets in risk-free instruments such as Treasury bills or money market accounts.

The main objective of market timing is to avoid major market price declines. By avoiding significant downturns in the market with market timing, you can achieve vastly superior returns over a buy-and-hold strategy. If an average bear market reduces the value of your portfolio by 20%, you need a 25% return to get back to the level where you were before the decline. Studies show that over the last 70 years, 42 were spent either waiting for a bear market to end or returning to breakeven. With buy-and-hold, this would mean that you would spend 60% of your time just trying to stay above water.

Market timing can produce significantly higher returns during bull markets, but you won't feel the real benefits until a serious market correction occurs. In those circumstances, a good timing system will slash market risk and reallocate assets to low- or no-risk instruments. Look again at Figure 1; instead of waiting for the bull market to resume, you could have allocated your assets into other investments to avoid the impact of the bear market. Even if market timing underperformed the market when it was rising, it would have more than made up for it during declining periods by ensuring minimum erosion to your asset base.

FIGURE 1: THE 1987 BEAR MARKET. It wasn't until 1991 that the market recovered from October 19, 1987, and resumed its bullish movement. Instead of waiting for this recovery, wouldn't you rather have put your money where it would continue to earn?

FIGURE 2: MARKET TIMING AT WORK. When prices fall below the 40-period moving average, you should move investments out of this sector and into...

FIGURE 3: MAYBE HEALTH CARE. The S&P health-care index is still above its 40-period moving average.

CONCLUSION

Market timing should definitely serve as a foundation to all your money management strategies. It can help you reduce losses during bear markets and improve the overall performance of your portfolio.

R.M. Sidewitz is chief executive officer and founder of Qi2 Technologies, LLC, an investment management company, and the managing member of Qi2 Partners LP, a domestic hedge fund. For additional information on long-term investing, go to www.longterminvestor.org.

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