Can You Really Time the Market?
During the long, strong bear market of the early 2000s, I was working for a bank. Revenues were suffering on the brokerage side of the business as clients sat tight in cash. One of the mantras that was used by sales teams to encourage stock sales amidst this tough environment was “you can’t time the market”, meaning that if you believe in a company you might as well just go and buy their stock and not worry about what the overall market is doing.
When the market hit prices which turned out later to have been close to the absolute rock bottom, which has held to this day, I did hear a few brave analysts say “Stocks are at a six-year low! Your clients should be buying stocks!” These guys seemed to believe that it was a good idea to try to time the stock market.
Obviously, the concept of market timing is primarily applied to stocks on the long side, i.e. timing the buying of stocks. We can test the question of whether “market timing” is a waste of time in this context using a very simple technical method applied to historical stock market data.
When is the Best Time to Trade the Market?
A very well-established trading signal is the cross of the 50-day moving average and the 200-day moving average. If the 50-day average crosses above the 200-day average (the “bull cross”), it is taken to be a bullish sign that the market is going up. Conversely, if the 50-day moving average crosses below the 200-day average, it is taken to be a bearish sign, showing that the market is going to go down.
Taking historical daily data from the major U.S. stock index, the S&P 500, since 1970, we can use the “bull cross” signal to determine whether market timing is a profitable approach. This is done by comparing average price changes in the index over a future period between the days when bull crosses occur, to future price changes in general.
The results show that when it comes to buying the major stock index, using the bull cross has been a more profitable approach than buying randomly, indicating that this can be the best time to trade and suggesting that the market can be “timed”. Buying the index upon a bull cross produced an average return of 4.70% holding for 3 months, 7.08% holding for 6 months, 11.88% holding for 1 year and 17.94% holding for 2 years.
These results can be compared to buying randomly, which is obviously a much bigger sample as there have been only 24 bull crosses since 1970. Here, average returns were achieved at 2.04% holding for 3 months, 4.21% holding for 6 months, 8.63% for 1 year, and 17.86% for 2 years. Every single result is lower than its equivalent achieved using market timing through the bull cross, but it is notable that the differences were much more significant within the shorter-term holding periods.
So, there is evidence that market timing has worked in buying stocks, but what about in Forex transactions? The closest equivalent to buying stocks would be buying the U.S. Dollar, and we can perform a similar experiment using historical data for the U.S. Dollar Index, using the same bull cross and holding period methodology. My data begins in 1995 which was chosen arbitrarily. This is not precisely the same period as was used for the stock market index back test, which was more than twice as long, but it still represents twenty-one years of data.
To my surprise, you can also time the Forex market, or at least the bull cross on the U.S. Dollar Index. Buying the index upon a bull cross produced an average return of 1.78% holding for 3 months, 2.25% holding for 6 months, 1.98% holding for 1 year and 4.94% holding for 2 years.
These results can be compared to buying randomly, which is obviously a much bigger sample as there have been only 12 bull crosses since 1995. Here, average returns were achieved at 0.32% holding for 3 months, 0.69% holding for 6 months, 1.41% for 1 year, and 2.84% for 2 years. Every single result is lower than its equivalent achieved using market timing through the bull cross, but it is notable that the differences were much more significant within the shorter-term holding periods.
Although it is important to note that the “bear cross” (the opposite signal to the “bull cross”, where the 50-day moving average crosses below the 200-day moving average) did not produce superior results to selling the U.S. Dollar randomly, it did not work with the stock market index either.
It seems clear, based upon the testing of historical data shown here, that it is possible to time the Forex market, just as it is possible to time the stock market. The size of the moves in the Forex U.S. Dollar Index have, however, been shown to be much smaller than the equivalent increases in value in the stock market index. One way to compensate for this differential could be to use leverage intelligently and carefully, but great caution must be exercised in doing so.
Market Timing Strategies
We’ve already looked using moving average crosses of two key averages – a faster and a slower one – as a method for judging whether a market is ready to move in one direction. The moving average cross is a very well-established strategy, but is far from the best timing tool available.
Another timing method that has historically worked well is to simply look at a long-term chart going back a few months and ask if the price has been steadily rising or falling during that period. If so, and especially if it is breaking out of a range, then the odds can be taken to be in favor of that move continuing with some force.
When it comes to day trading shorter time frames, another timing edge can be gained by looking to initiate trades during the most active hours of the market, which are usually the best time to trade. When these coincide with the regular opening hours of major financial centers such as New York, London, and Tokyo, a timing edge can often be gained, as these times typically see an uptick in volume and often momentum too.
Finally, external factors should not be overlooked. When big political or economic events happen, especially if they change a consensus or balance of opinion, related markets are more likely to make strong directional moves, even if they do not seem to be logical. For example, the recent surprise result of the U.S. Presidential election moved most markets strongly, even if not in the directions that were necessarily anticipated. The crucial thing was, that the market was moving, and it had some fundamental or sentimental reason to be moving.