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Jump In! Jump Out! Using Market Timing

03/26/01 11:41:04 PM PST
by RM Sidewitz, Ph.D

Buy-and-hold notwithstanding, all investors want to be in when markets are rising and out when markets are falling. Even the simplest market timing strategies can help you do just that.

There have been 15 bear markets since 1929, and on average, they have chopped 35.1% off the Standard & Poor's 500 index. This means that if you had used a buy-and-hold strategy during this period, it would have taken years to recoup the loss. Look at the bear market that took place in 1987 (Figure 1). It wasn't until 1991 that the market finally stabilized and resumed its upward trend.

A buy-and-hold strategy sounds great. Why wouldn't it? The concept seems ideal: buying stocks of solid companies that promise future growth or investing in top-rated mutual funds without having to worry about their performance on a regular basis. But buy-and-hold can eventually end up in a devastating failure.

Buy-and-hold is actually an archaic timing strategy, the rules for which are:
  • 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?

In addition, buy-and-hold investing becomes dangerous when you need access to your investment capital relatively quickly, whether to buy a new home or for retirement purposes. Think about it. Suppose you have designed an investment plan such that you need to have the capital for whatever reason in 10 years. Suppose the market suffered a severe setback in that 10th and final year. The market correction and the ensuing bear market could wipe out one-third or more of your portfolio, preventing you from reaching your goal of buying a house or retiring. This would mean you would have to wait for an even longer time before having the capital you need.

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...

Market timing strategies don't have to be difficult to grasp. If you aren't comfortable employing such a strategy on your own, there are professional money managers who utilize market-timing systems. Most systems work well in reducing market risk, and some outperform the market averages. Even a simple 40-period moving average has worked effectively over the years. For example, Figure 2 shows a weekly chart of the American Stock Exchange (Amex) biotechnology index with a 40-period moving average overlay. When prices fall below the moving average, you should consider moving investments out of this sector and into the health-care sector (Figure 3). The S&P health-care index is still above its 40-period moving average.

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


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

Copyright © 2001 Technical Analysis, Inc. All rights reserved.

RM Sidewitz, Ph.D

Dr. Sidewitz is the President, 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. Dr. Sidewitz began his career on Wall Street in the mid-1960s with Moody's Investors Service. He then served as the Assistant Director of Research for a registered broker/dealer until 1971. In the ensuing years, he continued his pursuits as a private investor during which time he developed the proprietary methodology that is used by the Limited Partnership. Dr. Sidewitz is the author of two books, "How I Double My Money Annually in the Market" and "How to Stop Sabotaging Your Trading Success: Mastering the Inner Realm". He is a frequent contributor to numerous financial publications and continues to work closely with private clients.

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