A Market Timing method that works: Sell When the S&P 500 or FTSE All-Share Cross their 200 Day Moving Average
The point of this website is to advocate long term investing that harnesses the power of compound returns, with time horizons of ideally more than 10 years (in my case more like 50!) However we also want to provide a balanced view and simply rubbishing short-term investing and market timing isn’t sufficient enough to be instructive and educational.
Instead I would like to say that the vast majority of market timing strategies don’t work over the long haul. There’s a simple reason – the S&P 500 and FTSE-All Share, along with other countries’ main benchmark indexes, are very hard to beat over the long term. Even now in 2019 during this torrid period where the UK is faced with low-growth, an election, and Brexit itself; the FTSE All share has returned 9.53% year to date. I have included both indexes to suit UK and US/Canadian markets.
So are there any strategies that have a good chance of beating that return?
There is one. I intend to introduce you to the strategy, describe how it works, and provide a template for tracking it.
Sell when the S&P 500 dips below its 200 Day Moving Average. Then Buy back in when the S&P 500 rises above its 200 Day Moving Average. Ditto for the FTSE All Share here in the U.K.
If you are looking to get into stock market investing the basic rules still hold true: invest for the long term, and invest in lump sums, because generally across the board that will give you the best returns. What’s important for you to understand is that I am still advocating that strategy. If you had sold everything when Trump was inaugurated you’d have missed a 37.4% rally up to today. If you sold everything before Brexit, you’d have missed a 20% rally up to today.
However, if you have a bit of investing experience, and want a good chance of missing stock market declines of say 20% and above, there is a way to IMPROVE the buy-and-hold strategy with reduced volatility.
This article will take you through two things:
- SELLING – Sell when the S&P 500 index price is below its 200 day moving average
- BUYING – Buy when the S&P 500 index price is above its 200 day moving average
First things first: this does not constitute investing advice and it is NOT designed to help you time the market on a daily and weekly basis. After all, as we say often here at Frugal Investors, there simply isn’t a way to sustainably time the market over the long haul by buying and selling regularly. At best (as I outline here) there is a chance you can avoid crippling losses and therefore make above-average returns while you do so. The rest of the time you just need to be invested!
You may believe that you are safer in cash. The market timing model I am going to go through here should dispel that myth. There IS a way to avoid the brunt of the pain during a bear market and the back-tested data works back to 1901. This is a far better strategy then holding cash or trying to wait for a big crash in order to buy. Waiting in cash very rarely works.
Have a look at the following graph courtesy of Yardeni research, which shows the bull and bear market corrections since 2008 and the 200 day moving average of the index:
Can you spot the trend? Every time there’s a significant dip, it is preceded by the blue line (S&P 500 index) crossing the red line (200 day moving average).
STEP 1 – Sell when the S&P 500 dips below its 200 day moving average.
I am going to make a sweeping statement here that is backed up by substantial financial data. Market crashes do not come completely out of nowhere. There are predictors. The challenge is simply knowing which ones to trust and acting on them rationally and without emotion.
What is interesting in the above graph is that in 5 cases (38.5%) there was a brief moment when the market fell below its 200 day moving average. That was shortly after followed by a steep drop in asset prices. If you had sold immediately when the S&P 500 dipped below the 200 Day Moving average, in those 5 cases you would have made an almost immediate profit. This is a well-known phenomenon.
First let’s go through the hard part: what if you sell EVERY time it dips below the 200 day moving average, and buy back EVERY time it goes back above the 200 day moving average?
|CORRECTION DATE||Tripped 200 Day MA? Y/N||Average Return Using Market Timing Method|
|18th May 2010||Yes||+1.7%|
|10th August 2010||Yes||+1.03%|
|27th July 2011||Yes||+8.4%|
|17th May 2012||Yes||-1.59%|
|8th November 2012||Yes||-1.1%|
|9th October 2014||Yes||-1.01%|
|19th August 2015||Yes||+0.04%|
|31st December 2015||Yes||+2.47%|
|27th June 2016||Yes||-1.7%|
|1st November 2016||Yes||-0.9%|
|23 March 2018||Yes||-2.9%|
|11th-18th Oct 2018||Yes||-0.9%|
|23rd August 2019||Yes||-1.02%|
|Average Excess Return S&P 500:||0.19%|
The returns on a simple “moving average sell” strategy are a paltry +0.19% per year since 2009. The reason this is so low is that the strategy is just insurance against a market meltdown. And since 2009 there haven’t been any extraordinary market meltdowns. You haven’t really needed to time the market since then because the market has simply gone higher and higher.
What this proves is that you certainly don’t lose money by following this rule. If you end up buying and selling when the 200 day average gets briefly tripped in a Bull market you’ll make a marginally positive return. Remember, though, we’re not at the start of a Bull market any longer!
Now for the juicy part: how did selling when the S&P 500 dipped below its 200 day moving average do during the major bear markets since 1901?
Why Selling the 200 Day Moving Average Beats a Bear Market
The back-tested data is very sound. A detailed study was conducted on using a quantitative approach to how you allocate capital by Mebane T Faber and it can be accessed here. The main thesis is that stocks simply crush the return of other asset classes over the long term, however this can be improved upon by using the moving averages to strategically time Selling and Buying.
Here is a table summarising the S&P 500 and FTSE All-Share performance against the 200 day moving average Market Timing method during the worst annual falls on record:
|Bear Market Date||S&P 500 Performance||FTSE All Share Performance||Market Timing Model Performance|
|1907 Banker’s Panic||-30%||-15%||-0.1%|
|1930 Great Depression||-25%||-19%||+2.5%|
|1931 Great Depression||-44%||-23%||+1.41%|
|1937 Market Crash||-35%||-20%||-7.7%|
|1973 Arab Oil Embargo (1)||-15%||-31%||-15.6%|
|1974 Arab Oil Embargo (2)||-27%||-55%||+8.2%|
|1987 Black Monday||-26%||-22%||0%|
|2000-2003 Dot Com Bust||-42%||-48%||-1.5%|
|2008-2009 Great Financial Crisis||-49%||-33%||-13%|
As you can see the out-performance is phenomenal and it is superior in many ways to using puts/calls to time the market, because for the vast majority of the time you’re simply invested until things start to go down meaningfully.
When the market fell below its 200 day moving average on 7th November 2007 you would have sold your investments, as the index hit 1475. It went back and forth and then on 27th December 2007 tripped again, at pretty much the same level – triggering a Sell. It would remain below its 200 day moving average for virtually the entire bear market. In March 2009 the index hit 797.87, which is 45.9% off the level it was sitting at on 27th December 2007. A buy was triggered on 1st June 2009 when the index hit 942.87 and entered above the 200 day moving average again.
The fascinating thing is how simple the method is and how it continues to work into the 21st century. Famed market timer Martin Zweig became a household name when he predicted the 1987 market crash in October, in part, because of his understanding of moving averages. The 200 day moving average dipped a few days before stocks nose-dived 20% on Black Monday. Selling immediately when it dipped below the 200 day moving average allowed you to avoid the entire 26% fall.
The point is this: if you believe that one of your primary reasons for not being heavily invested in stocks is the risk of getting annihilated during a bear market, then you should realise by now, that’s somewhat unfounded. There is something you can do about it by following the moving averages for the indexes and Selling when the index price crosses below the 200 day moving average.
How to do it
The first part is straightforward. Find the data that you need on the internet and come up with a simple system to check it weekly, on your iPhone/Android phone or while you are on your PC.
To make this easier and efficient for you (it’s my job!) you can go here to access the Frugal Investor’s free excel version of the Market Timing Tool that I use to follow the 200 day moving average for both S&P 500 and the FTSE All-Share. The tool includes an excel macro that goes and updates the figures on a daily basis at the push of a button. Personally I like to see and understand the inputs and how the averages are calculated, so I built this myself.
What do you need for this to work? You require access to regular data on 1. The S&P 500 index price and where it sits against its 200 day moving average; 2. The FTSE All Share Index and where it sits against its 200 day moving average. Remember to get the S&P 500 index price and FTSE All Share index price is easy through Google or Yahoo Finance. Be aware that there are several different types of moving average charts so the numbers may vary. The Frugal Investors excel uses an un-weighted average for the last 200 trading days.
Using the Market Timing Tool – Don’t go overboard
Let’s clarify a few things. This is a Market Timing Tool that uses the moving average of major stock indexes to time entry and exit points. It does not trip that often. Momentum often carries the index down, sometimes by not very much, sometimes by rather large extremes. It is the extremes you are hoping to avoid by introducing a little strategic timing.
As you saw from the graph above and the data in the first table – when it comes to small market corrections and drops, in fact, this method doesn’t make you much money at all. You walk away with 0.19% extra above and beyond the S&P 500 index itself each year. On a £100k portfolio that’s a modest £100 extra return per year.
But? Well, there’s a huge but. During an average S&P 500 bear market the Market Timing model out-performs by a whopping 30.1% since 1907. During an average FTSE All Share bear market the Market Timing model outperforms by even more: 39.1%.
The point of all of this isn’t to detract you from long term investing. The point of this is to give you a data-driven way to avoid large bear markets and to ensure that you can happily invest your money for the long term. For some people knowing that you have a ‘fail safe’ may help you to commit your money for the long haul.
The challenge is that you need to follow the stock market indexes and their respective 200 day moving averages every week, and be prepared to act when they trigger a Sell. Be dispassionate. Using this strategy you would Sell and wait until a Buy is tripped.
The reward? Well, if you think a bear market could happen in the next five years, then by following this method now you are likely to avoid a good portion of the stock market carnage and therefore win yourself added returns. Simples!