I’m not a practitioner of market timing, and I’m not a proponent of it. That being said, I read an article about it in a recent issue of Kiplinger’s Personal Finance Magazine that made me reconsider.

To be fair, the article was more about timing big swings in the overall stock market as opposed to individual stocks. I still think trying to time individual stocks is a fool’s errand, but I’m wondering if it might be possible to time the market as a whole.

The article does make the point that most successful timers don’t move all in or all out at one time, but rather buy in or sell off in increments of perhaps a 3rd of their total at various points on the way up or down as signals switch. Again, this seems much more reasonable to me than the all or nothing approach that is often talked about in timing the market.

Without further ado, here are the 3 Key signals to timing the market as found in the Kiplinger’s article.

The yields and valuations signal.

Former Federal Reserve Bank economist Pu Shen says he has found that when the difference between the yield of either short-term or long-term Treasury securities and the S&P 500’s earnings yield (earnings divided by price) reaches “certain extremes” it can be an effective trigger. Unfortunately, the article fails to state what “certain extremes” means.

When back testing this over the 1970 – 2000 market returns, and simulating a move between stocks and cash on a monthly basis using short-term rates, an imaginary investor turned $1,000 into $101,000! That’s pretty impressive, but again, just where we set the trigger (i.e. what we decide those “certain extremes” to be) makes all the difference.

The market breadth trigger.

Dan Sullivan (manager of The Chartist newsletter), thinks that when advancing stocks outnumber declining stocks by 2-1 over a 10 day period a buy signal has been reached. This signal has only hit 11 times since 1949, the most recent being March 23, 2009.

The moving averages trigger.

You can see from this image of the 200 day moving average of the Vanguard Total Stock Market ETF (VTI) that the VTI crossed the buy signal around the beginning of June.

The moving average of daily stock prices is a common trigger for many market timers. Many websites such as StockCharts.com provide the charts for you, so this trigger becomes as easy as watching this line of averages for trends.

Many technicians believe that when the daily closing prices move above the average it is a buy signal; conversely, it is a sell signal when the line moves below the trend line (average).

Problems with the signals.

Obviously, these signals are not always 100% accurate. If they were, they would stop working anyway because investors would all wait for the signal and stop taking the actions that actually precipitate the signal in the first place – if everyone is waiting to buy until the price goes above the average, there will be no one buying to push the price up over the average. This is a simplified example, of course, but one for illustrative purposes.

Another problem is that signals that work in one environment often break down when the system enters extreme conditions. Case in point: The afore mentioned relationship between S&P 500 earnings yield and interest rates. Many economists believe that this signal stops working when ultra low interest rates become the norm, as they are today.

In the end, there is no perfect signal for timing the market, and those who are successful at it must rely on not only a good signal but also their ability to interpret the signal correctly and the discipline to execute a plan after the signal has been interpreted.

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