I have been involved in trading and in investing in stocks for four decades. I enjoy learning and writing about financial topics.
The holy grail that all stock market traders and active investors seek is a stock market timing method that actually works. Many financial advisors and commentators dismiss the notion that one can actually time the market to get out when a decline is occurring and get back in to ride the market up once a bull market returns. This may be true in the short-term, since nobody knows what news or developments will send the stock market higher or lower on a day-to-day or even week-to-week basis. However, looking out to a longer-term time horizon, there is a clearly a market timing method that has proven its worth over time, since it provides accurate signals regarding when to be in the stock market and when to step to the sideline and hold cash.
This stock market timing method uses what is called a “Twelve-Month Simple Moving Average (SMA) Chart.” A Simple Moving Average is calculated by adding the closing price of a stock or a stock market index, such as the Standard and Poors 500 (S&P 500) Index, for a number of time periods, then dividing the sum by the number of time periods utilized. For example, a Twelve-Month Simple Moving Average Chart of the S&P 500 Index (as depicted below) is constructed by adding up the monthly closing price for the index for twelve prior months, then dividing the total by 12. This yields an average price for the index over the prior 12 months, which is plotted on a chart at the end of the 12-month time period. This process is repeated for each month to construct this chart.
A Video Explanation of What a Simple Moving Average (SMA) Is
How to Use a Twelve-Month Simple Moving Average Chart to Time the Stock Market
The below chart is a depiction of the Twelve-Month Simple Moving Average for the S&P 500 Index compared to the actual trading level of the S&P 500 Index (the blue line) from 1995 until early 2018. The green dots are monthly points in time when the 12-month Simple Moving Average was above the level that the S&P 500 Index was at during the same month. Conversely, the red dots represent months that this moving average was below where the S&P 500 Index was trading.
So what does this tell us? Per the stock market timing methodology under examination, each green dot indicates a time that stocks should be held, while each red dot indicates a period when stocks should be sold and investors should hold onto cash or at least lighten up on their stock holdings.
12-Month Simple Moving Average Chart of S&P 500 Stock Index
Understanding the Twelve-Month Simple Moving Average of the S&P 500 Index Chart
A Twelve-Month Simple Moving Average of the S&P 500 Index Chart is all you need to obtain useful market timing buy and sell signals. As you can see from the chart above, following this market timing method would have allowed one to avoid the two steep stock market sell-offs that occured from the end of 2000 to the beginning of 2003 and again from the later part of 2007 to the early part of 2009. These two sell-offs are respectively known as the “Dot-Com Bubble Burst” and the “Great Recession” sell-offs. Being either entirely or largely out of stocks during these two steep bear markets would have resulted in a great amount of preservation of capital to deploy when the marketing timing indicator turned green and indicated it was time to be holding stocks. As you can see, there are some false indications of sell-offs, which are brief periods in which red dots appear. However, a disciplined trader or investor will simply get back into stocks once the Twelve-Month Simple Moving Average of the S&P 500 Index turns green again.
Essentially, following this market timing method not only allows one to step to the sidelines and hold cash during steep sell-offs, it also helps one hold onto stocks with confidence and ride the stock market higher during periods when it is rallying and is in a bull market phase. It is a backward looking indicator, so it will not allow you to get out and into stocks at the exact top or bottom of a trend reversal; however, as indicated by the chart above, that does not really matter since many sell-offs and rallies go on for many months and often many years. This indicator gives one plenty of time to react and benefit over long periods of time.
A Breakdown of the S&P 500 Index By Economic Sector
Read More From Toughnickel
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Stock Market Timing By SMA Charting The S&P 500 Index
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
Questions & Answers
Question: How reliable would stock market signals be on weekly charts where each bar would represent one week?
Answer: The problem with doing a Simple Moving Average (SMA) on a weekly rather than a monthly basis is that you'd be getting a lot more noise from market volatility and potentially false buy and sell signals. I suppose doing a weekly SMA would be helpful if you're more of a swing trader that gets into and out of stocks over a few days or weeks, but for long-term investing the monthly SMA is much better at filtering out market volatility/noise.
© 2018 John Coviello
John Coviello (author) from New Jersey on April 17, 2018:
That is certainly a good strategy Mary, especially if you're investing for the long haul, as the stock market eventually recovers from dips. Thanks for reading.
Mary Norton from Ontario, Canada on April 17, 2018:
Good that you found a timing method that works.Timing the market is the hardest challenge for any investor. Fear and greed play their part there. The best strategy that worked well for us is to spend time choosing the best-performing companies with solid earnings and market potential. When they go down in the dip, they are sure to recover.