Market Timing Strategies: (Backtest, setups and regime filters)

Last Updated on May 30, 2023

Plenty of investors try to time the market. Most are unsuccessful due to a number of reasons. Thus, most investors should not time the market. However, most of the failures can be attributed to a few reasons. In this article, we look at some elements that we believe are required for successful market timing.

At the end of the article, we give you several market timing systems and strategies we have backtested (and work well).

First, let’s start with defining what market timing is all about:

What is a timing model?

Market timing involves attempting to predict the future movement of an asset. However, predicting the future can be challenging to do accurately and is subject to many subjective factors.

To avoid this problem, we prefer timing models that are built using quantitative methods to make trading more mechanical and less discretionary. The rules for buying and selling are based on previously specified criteria, and personal opinions and predictions are not included in the model (obviously). We have written about this before:

The key to successfully trading a timing model is to closely follow the system and your strategy, assuming you have e a proper backtested market timing system. Even if you have an outstanding timing model, it will be useless unless you commit your money and follow ALL the signals. You don’t know beforehand which signal will be good or bad. Unfortunately, many abandon or override their system sooner or later, primarily due to biases.

Giving the model enough time to work is essential to achieve the best results. Short-term fluctuations can be unpredictable, so focusing on the long-term results of carefully chosen strategies/allocations and the model’s trading rules is crucial. If you stick to your plan and trading rules, you will likely be rewarded in the long run (again, assuming you have a valid strategy or system).

Let’s give you an example of a market timing system:

Market timing strategy example

An example of a market timing system is the 200-day moving average (a very simple system):

When the price breaks above the average, you buy. When it breaks below the 200-day average, you sell.

This strategy has performed well over many decades for stocks. Here is the return (log chart) of investing 100 000 in 1960 and reinvesting and compounding:

Market timing strategy example

The 200-day moving average strategy has displayed decent results:

  • There have been 187 trades since 1960.
  • The Compound Annual Growth Rate (CAGR) is 6.7%, while the CAGR of buy and hold is 7.1% (excluding reinvested dividends).
  • There is an average gain of 2.5% per trade.
  • The maximum drawdown is 28%, compared to the 56% drawdown with buy and hold.

The 200-day moving average strategy has nearly kept pace with the S&P 500 while experiencing significantly lower drawdowns and spending significantly less time in the market. However, one potential drawback is encountering tax liabilities due to non-deferred capital gains.

Is market timing a good idea?

For most investors, no. After reading this article, you’ll understand that it requires specific prerequisites to succeed. Most market timers fail, regrettably.

The risk of market timing is doing it wrong and thus underperforming massively. This is the potential cost of market timing. We recommend reading our prior articles on the potential risks and costs of market timing:

Attempting to time the market can be problematic if you attempt it for a period and then abandon it due to discouragement, opting for something more agreeable (the grass is always greener on the other side). For example, you decide to overrule the signal because you are bearish. But when you overrule a strategy, you can forget the backtested results. A system can’t backtest overrules, obviously!

Following your emotions may cause you to abandon your timing strategy at the most inopportune moment, such as when your investments are performing poorly, which inevitably happens.

Can you commit to a long-term strategy and remain dedicated to it? Will you adhere to the system, despite your sentiments and external pressure? Can you resist impulsive actions and disregard the abundance of “hot tips” you encounter regularly?

Are you independent and have self-confidence?

As indicated above, you don’t want to overrule the strategy, system, or model.

Investing holds few certainties, but one thing is sure: regardless of your investment performance, someone else will have recently outperformed you and appears to have struck gold. There are always investors bragging on social media, which might make you look like an idiot.

Anxious investors constantly look over their shoulders for someone who has discovered the “one true path” to wealth. However, this path is a myth, and nervous investors are not adept at timing the market. Trading involves inevitable losses and drawdowns.

Successful investors know their objectives, establish a strategy to achieve them, and remain committed to that strategy regardless of others’ actions. If you aim to increase your assets by 10 percent annually, and a timing system allows you to accomplish that, can you be content even if others are earning 12 percent, 15 percent, or even 20 percent? If so, you may possess the necessary attributes to excel as a market timer.

Remember, very few go on to beat the S&P 500 over the long run. The minority has managed over 10% for over a decade.

You are guaranteed to underperform from time to time

It may seem obvious, but how often people overlook this fact is surprising:

A timing system is not intended to generate identical returns as an untimed market. Achieving market outperformance is gratifying, but your satisfaction may be eclipsed by the anger or disappointment you feel when your portfolio underperforms, or your timing system results in a loss. This is particularly true when you are convinced that the signal generated by your system is incorrect.

Your system is not perfect and not a holy grail

The media’s primary criticism of timing is its imperfection. When you experience underperformance and losing trades, media critiques can undermine your confidence. Media often states that timing necessitates being right twice – when you buy and when you sell – as opposed to a buy-and-hold approach, in which being right only once when you buy is sufficient.

Typically, your system will get you into or out of the market “too soon” or “too late” to capture the tops and bottoms. If your goal is to exit at the absolute top and enter at the absolute bottom, timing is certain to disappoint you.

If this disappointment will drive you crazy, think twice before pursuing a timing strategy because the perceived timing errors will weaken or demolish your willingness to follow the plan. Rather than striving for perfection, aim to tilt the odds in your favor. And a solid timing strategy can accomplish that.

A good plan is often ruined by the desire to make the perfect plan.

Can you ignore the massive impact and noise from news?

The popular press appears to have a collective blind spot concerning timing, almost unanimously denouncing market timers. The mutual fund and brokerage industries widely share this view. Perhaps for good reason, since most market timers end up underperforming.

Can you sell your investments when everyone else is buying or already profiting? Can you repurchase when your friends, colleagues, the media, and even your own intuition are telling you that it is a foolish notion?

Do you procrastinate?

Certain individuals tend to worry, overthink, and postpone making choices even when certain about the course of action. Such people are improbable to succeed as market timers. Successful timing necessitates prompt action to enter and exit markets.

One of the most apparent facts about timing (yet commonly ignored) is that when your friends, colleagues, intuition, and experts concur on what you should do, it is already too late for you to capitalize on the maximum potential. If you typically take significant time to make decisions, market timing may not be suitable for you, and you are better off buying and holding.

Do you trust mechanical trading strategies and systems?

Timing financial markets is already an incredibly challenging task, without the added pressure of making predictions or feeling obligated to choose which smart economists or experienced analysts are correct when their forecasts and conclusions conflict.

If you rely on subjective factors to make final decisions, you will never be confident about what you should do at any given moment, leading to anxiety and procrastination. Consequently, you’ll have an unreliable system.

Instead, depend on trend-following systems that rely mainly on trends influenced by actual market prices. There’s nothing speculative about prices; they mirror the actions of buyers and sellers, making them an extremely dependable gauge of the market’s direction.

One or a few trades mean nothing

The vast majority of individual trades will not significantly impact your long-term outcomes. If you find yourself fixating on each trade and excessively worrying about its implications, it indicates that you are not suited to be a successful market timer. Focusing excessively on every trade is a guaranteed method to drive yourself insane and will not improve your results.

Only use systems that fit your personality

The ideal strategy for you will align with your time horizon, consider your emotional needs, and remain within your risk tolerance and capacity for change. There are short-term systems that trade frequently, long-term systems that trade infrequently, and intermediate-term systems that typically execute two to six trades annually.

Over extended periods, no group holds an inherent return advantage over the others, but practical and emotional differences are significant.

If you have a strong desire to closely mirror the market’s performance, then utilize short-term systems that react rapidly to today’s highly volatile market fluctuations. However, short-term systems necessitate numerous trades, and each trade can have potential tax consequences unless you are investing in a tax-sheltered account. The volume of trades requires substantial attention, produces significant paperwork, and can test the patience of many mutual funds that may decline accounts from very active timers.

Conversely, if you strongly dislike whipsaws, opt for long-term systems, but this will sometimes require waiting for a 20 percent or more move before buying or selling. For the best compromise, consider using intermediate-term systems, which are likely to be accepted by most mutual funds and are not overly demanding emotionally.

Use many strategies and systems that complement each other

The most efficient system in the past may not be a strong performer in the future, and vice versa. Thus, you should not rely on a single high-flying timing system that has performed well recently, similar to how you should not chase recent performance when selecting mutual funds or asset classes.

In reality, “superstar” timing models do not exist; they are a myth. Good performance in one year has no bearing on performance in the next year – none at all. This is one of the most difficult truths for investors to accept, but it is accurate. As a result, we believe that your best option is to locate several robust timing models and stick to them.

You need to diversify. You should have systems for different time frames and asset classes. Different asset classes are important for a market timer:

Asset allocation is important for market timers

Incorporate numerous assets or asset classes that fluctuate at varying times. Incorporate international diversification, whether you invest in equities, bonds, or a combination of both.

Just as you are unaware of which timing model will perform exceptionally in a specific quarter or year, you also do not know which asset class will exceed expectations and which will underperform.

Prepare for tough times

Implement your strategies without hesitation and without exception. If you do only one thing right and everything else wrong, ensure that this is the one thing you do correctly. This is the most crucial key of all.

You can devise the most exceptional portfolio in investing history, but it will be of no use unless you invest your money in it. The greatest timing models are of no use unless you apply them. Therefore, do whatever is necessary to accomplish it.

Market timing systems and strategies need time to work out

Anticipate the obstacles you are likely to encounter and focus on the potential rewards of your strategy. Receiving the benefits of success will be straightforward.

However, you will never reach the finish line unless you can overcome the hurdles along the way. Understand the extent of temporary losses you may face with your approach and ensure you are prepared to accept them.

For example, in the early 1970s, buy-and-hold investors in the Standard & Poor’s 500 Index suffered a 39 percent loss in one year. Even timing can be unpleasant. To sum it up, do not anticipate any timing system to be a magic solution.

Use both buy and hold, asset allocation, and market timing

In the long run, if you have chosen a strategy thoughtfully and adhere to the discipline, you should be suitably compensated.

However, what is the appropriate length of time to wait? There are two factors to consider. The first is your psychology. Do you typically undertake long-term projects or strategies and are comfortable knowing that any payoff will require patience? If so, you may be an ideal candidate for market timing.

Conversely, if you quickly judge the success or failure of something you initiate and require instant gratification, you may struggle to be a successful market timer.

The second factor is statistical and historical data. Arm yourself (or have your manager do so) with your proposed investment’s past statistical performance, either real or hypothetical. Determine the largest drawdown over the longest period for which you have data. Find out how long it took to return to break-even.

Here’s a challenging example of the incredible patience required of investors: in 1973 and 1974, the S&P 500 decreased by 44.9 percent, and it took 66 months for some investors just to break even. If you are uncertain whether you will stick with a strategy through the longest historical drawdown for which you have data, do not attempt that strategy. Also, the biggest drawdown is yet to come.

Market timing might involve underperformance – don’t put all your eggs in one basket

By employing both buy-and-hold and market timing strategies, you will most likely have two uncorrelated approaches that will produce different outcomes in any given period.

Over extended periods, thoughtfully selected investments in comparable assets may yield comparable returns with both buy-and-hold and market timing.

However, in the interim, the average of the two methods may result in reduced losses, lower risk, and, most significantly, less anxiety than either market timing or buy-and-hold alone. This combination may be more attractive to many individuals than the ups and downs of each approach independently.

Market timing strategies and systems that work

We have covered many market timing systems on this blog since its inception. We list a few of them:

Successful market timing – conclusions

Ensure that you are ready for potential challenges that may arise, and make sure you are using backtested and “proven” timing systems with clear trading rules. Also, make sure you are ready and able to follow the signals.

This the main requirements for successful market timing!

List of investment strategies

We have written over 1200 articles on this blog since we started in 2012. Many articles contain specific investment rules that can be backtested for profitability and performance metrics.

The trading rules are compiled into a package where you can purchase all of them (recommended) or just a few of your choice. We have hundreds of investment ideas in the compilation.

The strategies are taken from our landing page of investment strategies.

For a list of the strategies we have made, please click on the green banner:

These strategies must not be misunderstood for the premium strategies that we charge a fee for:

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