Tried and true market signal vs. “Fundamental Analysis”

Something I wrote down many years ago when I first started following and investing in the stock market was…

Best long-term market timing system:

20 week moving average crosses over the 50 week moving average by one percent you go long… If it goes below by more than one percent you sell.

Everyone talks about esoteric technical systems like Elliot Wave or some crazy “can’t fail” chart pattern but in reality stock technical analysis boils down to two things.. support (and resistance) and most importantly TREND.

The 20/50 helps you get the trend part right.

How can you argue with a strategy (the 20/50) that:

- Got you to buy in the year 1994 at around S&P 450.
- Didn’t tell you to sell until year 2000 at S&P 1400.
- Got you back in the market in 2002 at S&P 900.
- Told you to sell again in Jan 2008 at S&P at 1450.

So given I know this signal and respect it, tell me what I was thinking back in the summer of 2009 when these two moving averages crossed again and gave a BUY signal at around S&P 1000? Why didn’t I buy there, I was actually just finishing selling my last longs at the time and shorting some things.

See Chart:

Basically I thought… “It’s different this time”.

The market had run from 666 to 1000 is just a few short months. I was long for most of it and felt like a genius.. Fundamentally I saw the economy was still very weak and there were many reasons good for us to go lower. All of these have been covered in my blogs and in other folks blogs.

I ignored the signal and did NOT go long. The only thing the signal did was keep me from trying to short and made me put ultra tight stops on the few shorts I tried because I realized the trend was against me. So the signal saved me lots of money I could have lost shorting but I did not buy the signal because of “fundamental analysis”.

A couple of weeks ago the market topped out at 1220, a full 20% above the 20/50 signal point.

That’s 20% that I missed on the long side because I didn’t follow a simple signal. There is a reason old pros say things like “charts don’t lie, people do”, “the trend is your friend”, “the market can stay rational longer than you can stay solvent”, etc.

It is because the market can always find a reason to go up or down that is disconnected from the fundamentals and informed participants are always surprised how far it will overshoot on the upside AND the downside.

The market is driven by panic, euphoria, outright manipulation, greed and a myrid of other human forces. In the long run it is fundamentals of course, but the long run is MANY YEARS.

So in summary the market has not really gone anywhere the last few weeks and you can see the red line gaining on the blue line in the all important chart above… Maybe the market has topped (no one knows for sure), but what I am SURE of is that the person who WAITS for the signal on the long and short side will always DESTROY the person who tries to pick bottoms and tops.

Trust the predefined mathematical market signals you believe in (whatever they may be) and not fundamental analysis if you are going to try to time the market.