Market Timing for a Rules-Based Strategy

Any strategy that trades stocks needs some sort of market timing mechanism to identify bull and bear markets. Typically, stock strategies are fully invested during bull markets because risk is acceptable. Strategies move to cash during bear markets because risk is above average. Preserving capital during bear markets is important to long-term outperformance (see SystemTrader).

Here is a simple idea for a market timing mechanism. First, use the S&P 500 SPDR (SPY) to represent the US stock market. SPY is based on the S&P 500, which is the most widely used benchmark for US stocks. Second, apply a long-term trend indicator for broad market timing. The chart below shows SPY with the Trend Composite. This indicator aggregates signals in five trend-following indicators. It is currently at +5 and still signaling a long-term uptrend (bull market). Note that this indicator is part of the TIP Indicator Edge Plugin for StockCharts ACP.

The chart above starts in 2022. Notice that the Trend Composite was mostly negative (bearish) in 2022. Strategies trading stocks would have been mostly in cash during this bear market and this would have preserved capital. The Trend Composite turned positive in February 2023 and has been mostly positive the last 19 months. It spent three weeks in negative territory from late October to mid November 2023 (whipsaw). Strategies trading stocks would have been mostly long during this period and participated in the bull run.

Strategies should have well-defined rules governing decisions. Stocks moved sharply lower last week, but the Trend Composite has yet to turn negative and signal a bear market. Similarly, the Composite Breadth Model, which times the market for our Dual Momentum Rotation Strategies, has yet to turn bearish. Thus, our strategies remain invested in stocks showing strong upside momentum. They will move to cash when a bear signal triggers. Click here to learn more. 

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