Trying to time the market often leads to big problems for most investors. But Validea CEO John P. Reese says that, in the hands of a highly disciplined investor, a rules-based market-timing strategy can yield stellar results, as it has for him.
“With market timing, the danger is less about the activity itself and more about how you go about it,” Reese writes in a column for Proactive Advisor magazine. “Many market-timers have little knowledge about how the market moves over time, they jump in and out of stocks or indexes based on what everyone else is doing. Their decisions are based on emotion rather than research or logic — and that usually leads to trouble.”
Reese, on the other hand, developed his timing model after he thoroughly back-tested 16 different market-timing strategies. “The strategy that showed the best results was an asymmetrical timing model,” he says. “On the sell side, the market has to close below certain key technical levels and selling needs to be accelerating, which will show up when a shorter-term moving average crosses below a longer-term moving average. The buy trigger is less stringent –it only requires the market to close above a certain shorter-term technical level. As a result, the strategy has a bias toward being in the market and not selling too quickly.”
Reese’s back testing shows that a disciplined investor who invested $100,000 in the S&P 500 in 1971 and then moved in and out of the market based on the strategy’s signals would have had just over $3.7 million by the end of August 2015, compared to $2.1 million for an investor who bought and held the index.
While the strategy has worked exceptionally well over the long haul, Reese says it can be a difficult one for investors to follow. “Because it waits for a significant uptrend to be confirmed before buying, it may not capture a portion of the gains that occur early in a bull market – and those are often quite strong,” he writes. “In addition, testing shows there is a 60% chance the buy/sell signal will be wrong. The long-term data indicates it is worth it to deal with the head fakes, but seeing consecutive incorrect signals as the market advances higher can be difficult for even the most disciplined investors.”