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The Secret to Market Timing

By Ari Charney on February 2, 2018

Nothing has more allure for investors than the possibility of market timing.

After all, market timing is really just another way of buying low and selling high.

In the investment arena, there’s no shortage of would-be gurus touting their ability to time the market.

But I used to track dozens of market timers for a living during my Hulbert Financial Digest days. And what I found is that market timers almost never beat the market.

Instead, they typically lag the market by a wide margin. In the end, their subscribers would be better off in an index fund.

Part of the problem is that most investors have an unrealistic expectation of what it means to time the market. They think market timing is calling the absolute top and absolute bottom in every cycle.

But there’s no single indicator—or even blend of indicators—that can tell you when the market is at a top or when it’s finally hit bottom. The sad reality is that these consequential events are only ever apparent in hindsight.

The Truth

Most market-timing systems aren’t really designed to call the market’s turns anyway.

That’s because most market timers are trend followers. They use technical analysis, such as moving averages and Bollinger Bands, to tell their subscribers whether to go long or move to cash.

Given the market’s inherent volatility, these systems tend to generate a lot of buy and sell signals. And it’s the sell signals that actually prove the most costly.

Since the market rises about two-thirds of the time, a system that has you go to cash several times a year can cause you to miss out on some pretty big gains. That’s why most market timers are actually market laggards.

This doesn’t mean they don’t occasionally get it right. Indeed, it seems like every market timer has at least one great call they can dine out on for the rest of their career—whether it was buying in at the market’s bottom in 1974 or dumping everything during the summer of 2008.

But for such systems to be truly profitable, they have to get the other side of the trade right too. And what these timers won’t tell you is that inevitably they stayed way too long in cash—or watched their portfolios get crushed when they missed the next top.

In fact, I’ve only ever seen one market timer successfully call both the top and the bottom of a market cycle.

This guy had the uncanny foresight to tell his subscribers to go mostly to cash near the Dotcom bubble’s peak in March 2000, and then go long again three years later when the market was still near its low.

Unfortunately, this performance comes with a huge asterisk. Shortly after he told his subscribers to sell in 2000, he inexplicably recommended a short-term trade that was bullish on the Nasdaq. And everyone got burned … badly. As a result, he got almost no credit for his otherwise incredible feat of timing.

There Is a Season

At Hulbert, however, we did find one timing system that consistently beat the market over the medium and long term.

It relied entirely upon seasonality—the market’s recurring patterns of readily observable strength and weakness.

For instance, the market tends to exhibit stronger-than-usual gains during turns of the month and in the days leading up to certain holidays.

While we can’t know definitively why it behaves in this manner, there are real-world actions that may explain the market’s performance, such as the timing of payrolls and subsequent investments in retirement accounts.

Over the long term, this system beat the market by about 1 percentage point annually, while reducing risk by about 40%. One point per year may not sound like all that much, but over time all that compounding actually makes a big difference.

Beating the market while incurring significantly less risk? That’s the sweet spot of investing.

Extra Seasoning

Interestingly, Investing Daily’s resident options guru, Jim Fink, uses seasonality at the core of his proprietary trading system for Options for Income.

Just like the market, the stocks underlying each options trade exhibit their own seasonality. Though we don’t always know why that’s the case, there’s usually a correlation to a company’s business cycle.

Some companies might book most of their profits during certain times of the year, and traders will start making moves in anticipation of this. Gas utilities, for instance, generate the vast majority of their earnings during winter.

When Jim researches new trade ideas, one of the things he looks for is stocks that consistently make gains during the same period—year in and year out. These highly predictable stock movements are part of what underpins his extraordinarily high win rate.

There’s a lot more to his methodology, as well, of course. Still, I’m a big believer in seasonality because, before I ever even knew Jim, I had seen it work for a market-timing system with a successful 30-year track record.

In this case, Jim has taken a good thing and made it even better.


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