I play the stock market for a hobby (and also because it helps me take in revenue that allows me to work at a job that I enjoy but pays little) most of the time rather successfully, but I am very hesitant to give advice since I don’t want people to get mad if I lose them money. The one time I gave even a brief opinion on the stock market on TMV was in a comment last fall and was horribly wrong…so.

That said, we are at a critical juncture in the market right now and it provides the perfect opportunity to give a quick word of advice on how to read the market over the long term. Hopefully this post will really give a perspective on what people mean when they talk about the market moving due to a “technical” reason.

To summarize: people are lying when they say you can’t “time” the market. Sure you may not know what is going to happen today or tomorrow, and there is no way to know when a “top” or “bottom” has been reached, but when you are talking about a cyclical bull or bear market (that may last 2-7 years) it is very easy to time. The myth that you can’t is perpetuated by mutual funds and other big money types that need money to flow in constantly, or at least stay put.

When talking about these long time frames, the two things to pay attention to are the 50 day moving average and 200 day moving average. If the 200 day moving average is rising, then it is a “bull market” and stocks will most likely continue to rise, and if the 200 day moving average is falling, then it is a “bear market” and you should be out. Over the course of a cycle, the stock market tends to “test” the 200 day (i.e. rise or fall to it to see if it holds) then bounce off it, and then test the 50 and bounce off that, then test the 200 again and repeat. This continues until the market starts drifting from indecision and the 200 flattens, and a test of the 200 fails.

In general, I would recommend being in the market if the 200 day is rising, selling the first time the market successfully tests (meaning goes up to and then falls) the falling 200 day average and buying when the market breaks through the 200 day.

Following these guidelines, I have a few charts to show. Here is the last bull market with a green where I would buy and red where I would sell:

Here is the tech bubble (the Asian crisis caused a small period where you’d be out, but you’d get back in at nearly the same level):

The same concept works for bear markets. Here is the tech crash (blue is where it bounces of the 50, to show the 50/200 day alternation and I’ll get to the orange in a minute):

And even the Great Depression wouldn’t have been that bad for your portfolio:

So what does it look like now?

As you can see the current crash has moved in rather predictable waves, other than earlier this year when I thought it was going to break through the 50 and go to the 200 but instead the 50 held. Right now the 200 day is rather flat, signaling indecision, and I think it looks very much like the orange highlights in the tech bubble crash. If the market rises 5% or more from here to get the 200 day to rise, then comes down and tests it and takes off, then I would buy into the market. However I think it is much more likely that we are about to see the next leg down. In either case, using the moving averages gives context and helps be objective.

How well does this system work? Well I’m too lazy to calculate it myself, but this post talks about if you buy when it’s above the 200 day and sell when it’s below and shows that the difference is considerable. Even more to the point, you’re not in the market during the most volatile times, so the risk-adjusted return is much better (plus you can put your money in a CD or other safe investment and make the difference even larger). The returns are even extraordinary if you short the market (meaning making money as it falls) during bear markets instead of sitting out, but that’s more advanced.

I think my suggestion to pay attention to the direction of the moving average as well as the position (which I got from AlphaTrends.Net who is the best technical trader I’ve seen) would be superior to the link above simply because there are a lot of false breakouts that the big money uses to trap people that get too excited. They will push the market either below or above the 200 specifically because a lot of people pay attention to it, but don’t do so for long enough that the direction changes as well. If you look at the graph there were only a couple false triggers from the rules I mentioned.

Anyway this is just a brief overview that hopefully people will find edifying, and when you read about “technical” moves it often means one of the large multi-month moves to test the 50 or 200 day. When I learned about it the first time I was aghast at how wrong the “common wisdom” was and it’s saved me a lot of grief.

Update: I should point out that their chart isn’t dividend adjusted and tax concerns will negatively impact the market timing strategy (although most people have the bulk of their money in tax-free retirement accounts so that’s not as big of a deal). Here is a paper that discusses the results in depth.