Market Timing

When you look at charts of long-run stock returns, the road to wealth seems obvious: You want to own shares during bull markets and sidestep those nasty market declines. Yet that has proven extraordinarily difficult to do. Stock market gains and losses tend to occur in short bursts, so it’s all too easy for market timers to be caught flat-footed. While market-timing was popular decades ago, today money managers typically stay fully invested in the market, and instead try to add value through stock-picking.

But doesn’t it make sense to steer clear of stocks when they are well above their historical valuations? Problem is, stocks can stay overvalued for many years and may never revert to the low valuations we’ve seen in the past. Shares have, by historical standards, been expensive for much of the past 25 years. Those who took that as a sell signal would have missed the 2000–02 and 2007–09 bear markets—but they would also have missed the huge gains of the 1990s, when U.S. stocks returned more than 400%, including dividends.

Instead of focusing on valuations, some investors try to divine the market’s direction by studying stock-price movements and searching for patterns. This search drives so-called technical analysis, which is the study of past security-price movements in order to predict what will happen next.

For instance, among market timers, a popular strategy is to track the stock market’s 200-day moving average. If the stock market moves above the average closing price for the past 200 trading days, this is taken as a buy signal, while falling below is seen as a signal to sell.

Does this work? For a February 2013 article for MarketWatch.com, Mark Hulbert, founder of the newsletter Hulbert Financial Digest, looked at how you would have fared historically if you had used the 200-day moving average to time the market. He found that, since 1990, your annualized return would have been just 3.8%, compared with 7.3% if you had simply bought and held stocks.

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