-Dugald Malcolm, Montreal, Canada.

At the beginning of August I questioned whether or not we were going to see yet another whipsaw in the market. Sure enough the market did just that, with another violent reversal in price movement. So, in looking back at the performance of the S&P 500 over the last few months, June saw a loss of 5.4%, July had a gain of 6.9% and August has put in a loss of 4.7%, the worst August performance since 2001. And now, we start off the month of September with another change in momentum to the upside, with an impressive rally of nearly 3%!

Timing these kinds of markets can be a nightmare for investors. A popular technical tool many investors employ when timing their entrance to and exit from the market are the moving averages. The most widely followed of the moving averages are the 50-day and 200-day Simple Moving Average (SMA). As the name suggests, the moving averages are computed by calculating the average price of a security over a set time period. The benefit in doing this is to smooth out the securities price movement in order to better establish a visual trend.

The averages can be used in a variety of ways to time the purchase or sale of a security. Eric and I have referenced on several occasions the crossing of the two moving averages. When the 50-day moving average crosses above the 200-day moving average a bullish signal is established in what is known as a Golden Cross. If, however, the 50-day moves below the 200-day SMA a bearish signal is produced in what is called a Death Cross.

Another popular technique for timing using moving averages is when the price of the security itself crosses above or below the moving average. Crosses above the average, of course, are bullish and below are bearish. Since the 200-day moving average covers a greater time period, crosses above or below this SMA hold more weight with investors. In the chart below, one can see that using the 200-day SMA to time entrances to and exits from the market has been extremely useful in escaping some nasty market downturns:

While this strategy has been effective over the long run, it is not without its short-term hiccups. Problems can arise when false buy or sells signals are generated in the form of whipsaws. Since May of this year, for example, the S&P 500 has been back and forth across the 200-day moving average line a total of five times. Using the 200-day SMA as a timing tool during this summer has done nothing but produce commission costs in trading these false signals.

To help steer away from this situation I like to employ a longer-term average and avoid the daily charts. While not perfect, I find the 10-Month SMA on the monthly charts a more effective timing tool.

Using this method, one doesn’t fret about the day to day movement of the market. One can adjust one’s portfolio once a month at month’s end based on whether or not the monthly candle stick has crossed the 10-month SMA. While, of course, using longer-term time frames can result in lagging of the market, I believe that this is a small price to pay in being able to avoid the headache of the day to day bouncing back and forth that we are now witnessing.

Have a good weekend!