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Buy and Hold vs. Market Timing Strategies

Many investors were taught that buy and hold is the best investing strategy. None other than Professor Jeremy Siegel author of Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns And Long Term Investment Strategies is a strong proponent of the buy and hold approach. Yet in a recent editorial in the Wall Street Journal, Siegel stated that stocks were cheap now and investors should buy. Sounds like he is using a market timing strategy. With the DJIA at lows not seen since 1997, it has been very tough for the buy and hold crowd. Could you have done better by employing market timing strategies that worked?

Buy and Hold

Crestmont Research provides an excellent tool to measure the stock market returns over any time period that began in 1901 and ended in 2008. Called the Stock Matrix it provides a useful measure of the compound annual returns of the market over any period of time. For example, from 1997 through 2008 an individual taxpayer’s compound annual return would have been minus two percent. The compound annual return starting in 1987 through 2008 is two percent. I encourage you to take some time and review the chart at Crestmont, as Ed Esterling does a great job in the analysis. You would have done better in a bank savings account.

It is interesting to see on the Stock Matrix chart that the best an investor could do by exiting in 2008 was to have invested in 1982. This would have generated a four percent compound annual return. The returns generated by exiting in 2008 and entering in 1998 through 2008 are all negative. Not very surprising. Hardly a good sign for the buy and hold crowd.

The proponents of buy and hold told us to expect eight, 10, and even 12 to 15 percent returns on our money, depending which financial “sales person” was quoted. I suspect and hope that most of these sales people are no longer employed after espousing these untruths.

Market Timing Strategies that Worked

What if you held a twenty-year position that began in 1982 and you had been able to exit your long positions in 2001, a year after the beginning of the bear market of 2000. Again, looking at the Stock Matrix from Crestmont Research, your return would have been a compound average of 7 percent. That would be anice  market timing strategy if it worked.

The bear market of 2000 ended in 2002, as the market rose from there to the end of 2007. Again, what if you had been fully invested in the S&P 500 from 2003, after the last bull market began, and you were able to close out at the end of 2007, when the latest bear market began. In that case, your compounded return would have been 7 percent. Another nice return for market timing strategy if it worked.

Of course, hindsight is a wonderful thing. It is easy to look back and do this kind of “what if’s” and show how an investor could do well. It turns out, if you had followed a simple market timing strategy that worked, such a return is possible. On the monthly chart below there are several buy and sell signals that would have kept you on the right side of the trend. These market timing signals include the RSI crossing down through 50 as a sign a bear market is beginning. When the RSI rises up through 50 it is a sign a bull market is beginning. The 24-month Exponential Moving Average (EMA) also offers good market timing signals. Buy when the monthly S&P 500 rises through the 24-month EMA and sell when it falls through the 24-month EMA.

Next, the monthly MACD indicator also provides good buy and sell signals. When the MACD (the black line) falls through its 9-month moving average (the red line,) you receive a sell signal. The MACD rising up through the 9-month moving average gives you a buy signal. Finally, the Slow Stochastic (60) offers a sell signal when it falls through 80. When it rises through 20, it gives a buy signal.

These market timing strategies that worked were used to identify the major turning points in the market. The trades mentioned above kept you out of the majority of the two most recent bear markets. That in itself is better than the vast majority of investors have done.

All one had to do is own the one of the S&P 500 Exchange Traded Funds (ETFs) during the bull market. Using the same market timing strategies you could have participated in the move down using the short ETFs, increasing your return.

The chart above is a monthly version that is useful for the big picture of your market timing strategy. You can refine your view by using a weekly, daily, hourly and shorter time charts. While no guarantee you will be successful, investors who follow a market timing strategy can beat the market as well as the buy and hold crowd.

Since we are in a severe bear market, a time will come when you should go long based on the monthly chart. Looking at the chart above, that time is still a number of months away. In the mean time there are market timing strategies that help you to participate in bear market rallies. That is a story for another time.

The Bottom Line

Market timing strategies that worked offer investors a way to be on the right side of the trend. Of course, you should not expect to be perfect in the timing of your buy and sells. However, using the right indicators can go a long way to improving the odds in your favor. After all the reason we invest is to provide a secure financial future for our family and ourselves. We should employ every tool that works to assist us in that goal.