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Quite often, complex rules come from simpler
ones: some people torture the data enough to come up with an
optimized set of rules that supposedly provide superior performances
than the original system.
As an illustration, in All About Market Timing by Leslie N. Masonson,
starting from the simple Presidential Cycle timing strategy, the
author then shows an "optimized" system that invest in optimum
months of the Presidential Cycle. The strategy handsomely beat the
original Presidential Cycle system, however the rules are just crazy
to implement.
On the other hand, don't systematically reject any enhancement.
Backtesting
Any system's performances should be checked against both Bull
and Bear markets.
Outperformance should not come from few exceptional years but be
somewhat consistent.
Check how the system fared over various 5 to 10
years periods rather than how it fared over 30-50 years. The latter
may show impressive numbers but very few investors have 30-50 years
timeframe.
Self-Adaptive Indicators
It is preferable to use indicators or systems that are self-adaptive
to any - or at least most - market conditions.
A typical example is Valuation: avoid using absolute Valuation such
as Buy when Market PE < 20 but use relative Valuation such as Buy
when Market PE < 1/(10 years Government Bond). Valuation can be high
or low for extended period so relative criteria are best.
Use Multiple Market Timing Systems
Use several systems from different groups (trend anticipation, trend
following,...). Here are few simple Market Timing systems that you
can easilly implement:
Monetary (trend anticipation): Fed Fund Rate
Valuation (trend anticipation): Beating the Dow
with Bonds
Technical Analysis (trend following): Moving
Averages
Calendar (neither anticipation nor following):
Best 6 months, Presidential Cycle or both combined
Think Tactical Asset Allocation
Many people think of Market Timing as a binary system, that is 0% in
the Market or 100% in it.
It does not have to be that way. You can design a system that
progressively gets you in and out of the market as conditions become
favorable or unfavorable. It is like Tactical Asset Allocation but
as opposed to Tactical Asset allocators who try to predict the
future stock market move and adapt their positions accordingly, you
adapt your position automatically, unemotionally.
For instance, you can built a Market Timing strategy with 3
indicators and decide to progressively increase your stock
allocation for each indicator that turns positive. You can even set
minimum and maximum permitted percentage allocation to stocks.
Conclusion
Use Market Timing systems that have a rationale,
are simple, provide consistent results, are preferably self-adaptative.
You can build a successful Market Timing system
by combining several simple indicators from different groups (Trend
Anticipation, Trend following, Calendar).
For extra safety, design your system such that it
progressively gets you in and out of the market as conditions become
favorable or unfavorable.
To learn more about
Market Timing
and how you can further enhance your returns by combining it
with
Stock Picking,
visit
Stock Picking and Market Timing. |
Market
Timing - What's a Good System From a Bad One?