Technical Indicators for Long-term Market Timing
In this post I'd like to share some of the best ways I know of to stay on the right side of the long-term trend. I will stick to technical indicators on price action and the S&P 500, or this discussion could go on way too long. I employ the monthly chart for long-term timing; its perspective is broad enough to show the big picture yet nimble enough to capture the major trends.
Before I continue, it is well to remember that past performance is no guarantee of the future. I have tweaked the settings on these indicators to fit certain past market behaviour, which is otherwise known as curve-fitting. The sample size (or at least the one I am working with) for market crashes is low, so it is unwise to make definitive statements about the best indicator or best setting. Even with the data for SPX, starting in 1980, there is no one perfect indicator or setting.
Moving Average Crossover
One of the most popular approaches for market timing - with good reason - is the moving average crossover. I've found that the exponential moving averages (EMA's) tend to work better than simple averages for this application, and my favoured combination is the 6 and 12-month exponential.
At present the blue 6-month EMA of closing price is well above the red 12-month EMA, indicating an uptrend. The crossings seen in the above chart are in early 2008 (bearish) and mid to late 2009 (bullish). During the bumpy market of 2010 & '11, the lines came very close to crossing over but did not cross. So the signal ever since 2009 has been to 'buy' or 'hold' stocks (at least those in the S&P 500 index).
The volatility surge in October (see the long tail highlighted in yellow) brought out quite a few "Chicken Littles"; predictions of 50% markdowns and the next bear market abounded. In truth the swoon was a little harrowing but just by focusing on these moving averages - and ignoring the noise - you would have sailed through relatively unscathed.
MACD
Taking the moving average concept one step further, we know that the MACD oscillator is the difference between two EMA's, so we should be able to replicate the crossover system with this indicator. Indeed a bearish crossover would correspond to the MACD (light blue line) going negative, and as seen above its zero crossings coincide with the moving average crossovers on the main chart.
Now the advantage of the MACD is that a signal line is provided, which is just a moving average of MACD. As the bullish moving average crossover can be a bit slow to happen after a bear market bottom, we can instead look for a signal line crossover. The signal crossover in mid 2009 provides an excellent example; it occurs a full 4 months before the EMA crossover.
In this application I ignore the signal line when the MACD is above zero; I don't take bearish signal crossovers as sell signals and only consider the bullish crossovers. I use the 6 and 12 month EMA's with a 14 month signal line; you could use a shorter period signal line for faster response but this generates some false signals.
RSI
I use RSI(14) with a cross downward through 50 as the sell signal and a cross upward through 30 for the buy. The background colour on the indicator above covers only the 30 to 50 region. The RSI reacts quickly to market movement which is both its strength and its weakness; it provides timely signals but they can be spurious (see orange circles).
After the bottom in 2009 the RSI performed the best out of all these indicators for getting back into the market; it crossed above 30 after the second month of the uptrend. However during 2010 and '11 it oscillated around the 50 level, giving some unnecessary sell signals. In these cases I would take the recovery above 50 as a new buy signal. The question might also be raised, what if the RSI doesn't reach as low as 30 during a bear market sell-off ? The safest answer would be to wait until it crosses 50 again, but judgement is called for; a low of 35 or less would probably suffice.
Before I continue, it is well to remember that past performance is no guarantee of the future. I have tweaked the settings on these indicators to fit certain past market behaviour, which is otherwise known as curve-fitting. The sample size (or at least the one I am working with) for market crashes is low, so it is unwise to make definitive statements about the best indicator or best setting. Even with the data for SPX, starting in 1980, there is no one perfect indicator or setting.
Moving Average Crossover
One of the most popular approaches for market timing - with good reason - is the moving average crossover. I've found that the exponential moving averages (EMA's) tend to work better than simple averages for this application, and my favoured combination is the 6 and 12-month exponential.
At present the blue 6-month EMA of closing price is well above the red 12-month EMA, indicating an uptrend. The crossings seen in the above chart are in early 2008 (bearish) and mid to late 2009 (bullish). During the bumpy market of 2010 & '11, the lines came very close to crossing over but did not cross. So the signal ever since 2009 has been to 'buy' or 'hold' stocks (at least those in the S&P 500 index).
The volatility surge in October (see the long tail highlighted in yellow) brought out quite a few "Chicken Littles"; predictions of 50% markdowns and the next bear market abounded. In truth the swoon was a little harrowing but just by focusing on these moving averages - and ignoring the noise - you would have sailed through relatively unscathed.
MACD
Taking the moving average concept one step further, we know that the MACD oscillator is the difference between two EMA's, so we should be able to replicate the crossover system with this indicator. Indeed a bearish crossover would correspond to the MACD (light blue line) going negative, and as seen above its zero crossings coincide with the moving average crossovers on the main chart.
Now the advantage of the MACD is that a signal line is provided, which is just a moving average of MACD. As the bullish moving average crossover can be a bit slow to happen after a bear market bottom, we can instead look for a signal line crossover. The signal crossover in mid 2009 provides an excellent example; it occurs a full 4 months before the EMA crossover.
In this application I ignore the signal line when the MACD is above zero; I don't take bearish signal crossovers as sell signals and only consider the bullish crossovers. I use the 6 and 12 month EMA's with a 14 month signal line; you could use a shorter period signal line for faster response but this generates some false signals.
RSI
I use RSI(14) with a cross downward through 50 as the sell signal and a cross upward through 30 for the buy. The background colour on the indicator above covers only the 30 to 50 region. The RSI reacts quickly to market movement which is both its strength and its weakness; it provides timely signals but they can be spurious (see orange circles).
After the bottom in 2009 the RSI performed the best out of all these indicators for getting back into the market; it crossed above 30 after the second month of the uptrend. However during 2010 and '11 it oscillated around the 50 level, giving some unnecessary sell signals. In these cases I would take the recovery above 50 as a new buy signal. The question might also be raised, what if the RSI doesn't reach as low as 30 during a bear market sell-off ? The safest answer would be to wait until it crosses 50 again, but judgement is called for; a low of 35 or less would probably suffice.
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