Market Timing vs. Buy and Hold

Market timing is an important component of the TurnerTrends investment strategy. However, market timing is often the scapegoat used by investors that buy high and sell low. We believe market timing can be an excellent decision-making tool when you get ready to buy long or sell short. Without properly timing the market, you could do all the right things at the wrong time and still lose your shirt.

You could verify the stock’s fundamentals are the top of their peer group. You could make sure that insiders are buying and not selling. You could confirm that the pricing chart has shown a clear technical break-out. You could make sure you are not overpaying for a stock by comparing trailing-twelve-month and forecast PE ratios. You carefully keep your stock investment portfolio asset balanced, well diversified, and equally weighted. You could even make sure there are no shareholder lawsuits pending, new products in the pipeline, and a solid management team is in place.

In short, you could do every thing right for the right stock at the wrong time.

Taking a long position in a stock at the top of a bull cycle (see (1), below) means that in all likelihood, you will own a great stock that is losing you a lot of money. Too many novice, as well as, experienced stock market investors will make the mistake of buying at (1) and then end up selling somewhere near (2).

Even the so-called, buy and hold investor, would have bought at (1) and three years later just be breaking even at (4). This can be seen in the stock chart below (Fig. B). The investor who ignores the impact of market timing buys at (1) and sells a few months later at a huge loss. The buy and hold investor buys at (1) and is still holding at (2) hoping for a turn-around.

Timing the market incorrectly as shown in the example can prove costly at best, and financially devastating at worst. Of course, sitting here today and looking back at February of 2002, we can all see the best way to time the market was to be short at the top (1), when nearly everyone else was long and proclaiming the next great bull market.

And, we can certainly see that a buy and hold approach netted no gain, assuming Fig. A also fairly represents the average price of most stocks.

It doesn’t take a mental giant to understand that it makes more sense to be long in a bull market and short in a bear market. But, there’s the rub. How do you know today, if we are in a bull market or a bear market?

An even better question might be, "Will we be in a bull or bear market next week or next month?"

As good as we are at trend analysis, we don’t know that answer for sure. But, we do have a pretty good idea. Here is how we time-the-market:

We believe that overall sentiment of investors by measuring the number of new buy signals to new short sell signals, is a critical characteristic to consider when determining whether we are in a bull market or bear market. In the Fig A above, the green line represents the total number of new buy signals generated by the TurnerTrends Ratings for each month. The red line represents the total number of new short sell signals. And, the black line represents the composite of the two sets of signals.

This chart, which we generate on a weekly basis, is the key market timing tool we use for our trading philosophy. It is important to note that nearly all of the better stocks, over the past several decades have made their upward moves when the overall market sentiment was strong. And historically, three out of four stocks have followed the general market trend - up as well as down.

Looking again at Fig A, it is pretty easy to see a new bull market started in May-June of 2004 (3), and as of November (4) was still indicating a bull market. However, it is also showing us we are approaching a new resistance level at the 1,000 level. Over the past three years, market sentiment has only gotten this high two other times. And, each time it marked the top of the bull market and the beginning of a bear market.

We began going all into long positions after (3), and are still long (4), but have our Stop Loss settings high enough to get us out with a sizeable profit, should the market suddenly become bearish.

We always review stocks in light of the current Market Sentiment. We won’t add new short positions to the portfolio if the sentiment is bullish. Likewise, we won’t add new long positions to the portfolio if the sentiment is moving in a bearish direction.

Each week, our ratings system produces a list of all the new buy signals vs. new short sell signals. We accumulate these totals and plot them in our Market Sentiment chart. This chart provides us with the current pulse of the investors with regard to their bullishness vs. their bearishness. When this chart is strongly bullish, we tend to place more long positions than short positions. When this chart is strongly bearish, we tend to do the opposite. The Market Sentiment chart has proven to be a strong leading indicator of actual market sentiment and gives us an edge in the direction of our trades.

As for buy and hold: We just don’t believe in it. We are trend traders and will only stay long in a stock as long as its price appreciation continues to grow. Trends can last weeks, months, or years. But, the moment a stock’s price triggers our Stop Loss for that stock, we get out of it and look for another stock to buy (in bull markets) or short (in bear markets).