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Market timing: There's method in moving averages Add to ...

It’s the kind of advice we’ve heard so many times that by now it causes our eyes to roll, teenager-like, each time we are forced to endure the investing cliché again: “Timing the market is suicide. All you’ll do is lose money. You’re better to buy and hold.”

Well, roll your eyes and pay attention, because we’ve found someone who believes you can actually do quite well timing the market. And he’s not some fly-by-night yahoo with a complicated, secretive “system” to sell you. He’s Standard & Poor’s chief investment strategist and his strategy uses a simple, well-established market tool: moving averages.

Moving with the moving averages

S&P’s Sam Stovall recently examined the S&P 500 over the past four decades to see how well investors would have done if they had employed moving averages as market-timing devices, versus simply buying the entire index and holding it.

He considered single moving averages (50-, 65- or 200-day, taking both the simple moving average and the “exponential” moving average, which places more weight on the more recent days), using the moving average to mark the buying and selling point: The investor is fully invested whenever the index is above the moving average, and fully on the sidelines whenever it is below the moving average.

He also looked at pairs of these moving averages – in which the point where the two averages cross each other marks the buying and selling point. (The investor would be fully invested whenever the 50-day or 65-day moving average was above the 200-day average, and fully out of the market when the shorter average was below the 200-day.)

While the results were mixed for strategies that simply tracked the shorter-term moving averages, Mr. Stovall found that investors using the 200-day average and the average-crossover strategies would have generated appreciably higher returns over the past four decades.

Longer term better, cheaper

Mr. Stovall found that while none of his moving-average strategies had a particularly high frequency of beating the index on an annual basis (all were in the 30- to 40-per-cent range), they were all quite effective at protecting investors from the deepest market downturns while still capturing most of the market rallies. “What really makes following a longer-term moving average system desirable, in my opinion, is that it forces you to stay in the market for as long as possible, but then gets out of the way before any real damage is done to your portfolio,” he wrote.

The longer-term and crossover strategies have an added benefit: lower transaction costs to managing your strategy. Because the 200-day average and the crossovers are hit much less frequently than the shorter-term averages, the investor isn’t buying and selling nearly as often; in the case of the crossover strategies, buy/sell events occurred, on average, less than once a year.

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