| Free Article |
A Simple Short-Term Timing Indicator
by David Van Knapp, author of
SENSIBLE STOCK INVESTING:
How to Pick, Value, and Manage Stocks
and
THE TOP 40 DIVIDEND STOCKS FOR 2010:
How to Generate Wealth or Income from Dividend Stocks
September, 2009
If as an investor you believe that market timing is impossible or stupid, simply
click away from this article.
Over the past couple of years, I have developed a simple timing indicator that
has proved quite accurate for short-term market trends. By “short-term,” I
mean about two to four weeks. I call this indicator the Timing Outlook.
No timing system is right 100% of the time, and the Timing Outlook is no
exception. But I have found that it does tend to be directionally correct for short-
term forecasts. It tends to detect directional changes in the market within two or
three weeks of their beginning.
The Timing Outlook is of no use to day-traders or traders who are focused on
extremely short time frames. It was originally developed to supplement
fundamental-based analysis of individual stock purchases—the idea was to raise
the odds that such purchases would get off to a good start by having positive
market forces behind them.
But it has also turned out to be helpful in making sweeping market calls. In
particular, it helped get me into the 2009 market rally by April 2 (the rally began
on March 10), and it correctly suggested staying in the market through the
length of the rally up to the writing of this article, even as most commentators
were advising impending doom for long positions.
The Timing Outlook’s other use is in helping avoid catastrophic losses. In 2008,
for example, it influenced me to keep most of my Capital Gains Portfolio in
cash rather than in the market. That was a hugely successful decision. (I do not
use the Timing Outlook in making decisions for my Dividend Portfolio.)
The Timing Outlook is quite simple. It utilizes ten factors that are freely
available to anyone. All ten factors are equally weighted:
• Economic forecast. Over time, stock prices follow corporate earnings.
Corporate earnings, in turn, often depend on how the overall economy is doing.
Thus, I use the widely reported Conference Board's Index of Leading Economic
Indicators as one component of the Timing Outlook.
• Interest rates. Generally, falling interest rates are good for the stock
market and rising interests rates are not. I use a simple indicator based on the
Federal Reserve's widely publicized Fed Funds Rate.
• Market valuation. Low market valuations often portend market rises,
while high valuations suggest the opposite. I use two valuation indicators: (1)
The P/E ratio of the S&P 500 (as reported on Morningstar) compared to its
own historical average. (2) Morningstar's free Market Valuation Graph, which
compares the actual prices of the ~2000 stocks they cover to the “fair market
values” they have computed for those same stocks.
• Market trends. The final six components of the Timing Outlook are
based on trend identification. These six “technical” components can outweigh
the four “fundamental” components described above. That design is deliberate,
and it is based on the idea that for timing purposes, the most important data is
the current trend itself, if there is one. Many investors believe—and there is
some research to support this—that once a clear market trend has been
established, it tends to continue for awhile. Using the most basic of technical
analysis techniques, I look for both a short-term and an intermediate-term trend
for the Dow Jones Industrial Average, the S&P 500, and the NASDAQ. That
means that there are six trend-following components in the Timing Outlook.
The Timing Outlook is calculated from the ten components just described. Each
component can suggest a negative future direction of the market (worth 0
points), a neutral view (5 points), or a positive view (10 points). After all ten
components have been evaluated, the total points are added and divided by 10.
The result is a single number, between 0 and 10, which is interpreted as follows:
• 0 to 4: Negative outlook. The stock market is unlikely to rise over the
short term.
• >4 to 7: Neutral outlook. The stock market is not in a clear near-term
trend. Note that because the market's very-long-term trend (measured over
decades) has been upwards, a neutral outlook can be interpreted as slightly
positive.
• >7 to 10: Positive outlook. The stock market is likely to rise in the short
term.
I usually recalculate the Timing Outlook every two weeks, although I might do
it more often if the markets are changing quickly or displaying unusual volatility.
As stated earlier, the Timing Outlook is not meant for extremely rapid trading
decisions, but rather to improve the buy, hold, and sell decisions of investors or
traders who have a longer-term outlook.
The Timing Outlook is available pre-calculated, with appropriate commentary,
in my free Newsletter. For those who are interested in the details of how each
of the ten components are calculated, follow this link to a free Q&A about the
Timing Outlook.
by David Van Knapp, author of
SENSIBLE STOCK INVESTING:
How to Pick, Value, and Manage Stocks
and
THE TOP 40 DIVIDEND STOCKS FOR 2010:
How to Generate Wealth or Income from Dividend Stocks
September, 2009
If as an investor you believe that market timing is impossible or stupid, simply
click away from this article.
Over the past couple of years, I have developed a simple timing indicator that
has proved quite accurate for short-term market trends. By “short-term,” I
mean about two to four weeks. I call this indicator the Timing Outlook.
No timing system is right 100% of the time, and the Timing Outlook is no
exception. But I have found that it does tend to be directionally correct for short-
term forecasts. It tends to detect directional changes in the market within two or
three weeks of their beginning.
The Timing Outlook is of no use to day-traders or traders who are focused on
extremely short time frames. It was originally developed to supplement
fundamental-based analysis of individual stock purchases—the idea was to raise
the odds that such purchases would get off to a good start by having positive
market forces behind them.
But it has also turned out to be helpful in making sweeping market calls. In
particular, it helped get me into the 2009 market rally by April 2 (the rally began
on March 10), and it correctly suggested staying in the market through the
length of the rally up to the writing of this article, even as most commentators
were advising impending doom for long positions.
The Timing Outlook’s other use is in helping avoid catastrophic losses. In 2008,
for example, it influenced me to keep most of my Capital Gains Portfolio in
cash rather than in the market. That was a hugely successful decision. (I do not
use the Timing Outlook in making decisions for my Dividend Portfolio.)
The Timing Outlook is quite simple. It utilizes ten factors that are freely
available to anyone. All ten factors are equally weighted:
• Economic forecast. Over time, stock prices follow corporate earnings.
Corporate earnings, in turn, often depend on how the overall economy is doing.
Thus, I use the widely reported Conference Board's Index of Leading Economic
Indicators as one component of the Timing Outlook.
• Interest rates. Generally, falling interest rates are good for the stock
market and rising interests rates are not. I use a simple indicator based on the
Federal Reserve's widely publicized Fed Funds Rate.
• Market valuation. Low market valuations often portend market rises,
while high valuations suggest the opposite. I use two valuation indicators: (1)
The P/E ratio of the S&P 500 (as reported on Morningstar) compared to its
own historical average. (2) Morningstar's free Market Valuation Graph, which
compares the actual prices of the ~2000 stocks they cover to the “fair market
values” they have computed for those same stocks.
• Market trends. The final six components of the Timing Outlook are
based on trend identification. These six “technical” components can outweigh
the four “fundamental” components described above. That design is deliberate,
and it is based on the idea that for timing purposes, the most important data is
the current trend itself, if there is one. Many investors believe—and there is
some research to support this—that once a clear market trend has been
established, it tends to continue for awhile. Using the most basic of technical
analysis techniques, I look for both a short-term and an intermediate-term trend
for the Dow Jones Industrial Average, the S&P 500, and the NASDAQ. That
means that there are six trend-following components in the Timing Outlook.
The Timing Outlook is calculated from the ten components just described. Each
component can suggest a negative future direction of the market (worth 0
points), a neutral view (5 points), or a positive view (10 points). After all ten
components have been evaluated, the total points are added and divided by 10.
The result is a single number, between 0 and 10, which is interpreted as follows:
• 0 to 4: Negative outlook. The stock market is unlikely to rise over the
short term.
• >4 to 7: Neutral outlook. The stock market is not in a clear near-term
trend. Note that because the market's very-long-term trend (measured over
decades) has been upwards, a neutral outlook can be interpreted as slightly
positive.
• >7 to 10: Positive outlook. The stock market is likely to rise in the short
term.
I usually recalculate the Timing Outlook every two weeks, although I might do
it more often if the markets are changing quickly or displaying unusual volatility.
As stated earlier, the Timing Outlook is not meant for extremely rapid trading
decisions, but rather to improve the buy, hold, and sell decisions of investors or
traders who have a longer-term outlook.
The Timing Outlook is available pre-calculated, with appropriate commentary,
in my free Newsletter. For those who are interested in the details of how each
of the ten components are calculated, follow this link to a free Q&A about the
Timing Outlook.
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