Sunday, July 22, 2007

Timing Indicators

Investing is so complex that one-decision timing indicators have a natural appeal. There's a near-limitless smorgasbord from which to choose, including a huge number of paid systems (like those seen on late-night infomercials).

However, every technical indicator -- MACD, stochastics, Williams%, ADX, etc. -- is a condition metric of some type, and can be easily pressed into service as a timing indicator free of charge.

This post examines nine, non-proprietary indicators, and includes live links for each (bookmark this page and keep up with their progress). It's a completely arbitrary list, so please share any favorites that aren't included here.

Do they work? Critical caveats aside, timing indicators can be effective if used correctly. However, the caveats are very important, and below are five of the biggest:

1. There is no such thing as a perfect timing indicator. Period.
2. All timing systems have statistically significant margins for error.
3. To improve their efficacy, timing systems should be used in combination with other metrics.
4. Even the best timing indicators give false signals.
5. One of the biggest problems is lag: the signal may be correct, but it happens either early or late.

Bottom Line #1: There are no genuine shortcuts to being a good investor. No timing system in the world can compensate for poor stock selection.

Bottom Line #2: The very best timing systems are good at avoiding drawdowns. However, the vast majority underperform the indexes over time.

For the record, as of Sunday, July 22, eight of the nine indicators listed below are on a Buy.



The indicators below are in grouped in five types: Moving Average, Options, Volatility, RSI and CCI.

Moving Average Systems

1. 5-10-20 Live Link

This is perhaps the granddaddy of all market timing systems. It uses EMA (20), (10) and (5), and has above-average effectiveness. A Buy is triggered when both EMA(5) and (10) cross above (20). A Sell is triggered when both EMA (5) and (10) cross below (20). Note that the current chart has been on a Buy since March, and wasn't shaken out during the May-Jun consolidation. For novices, 5-10-20 is a good place to start.

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2. Beisiegal Live Link

Dan Beisiegel of Illuminant Capital developed a system that uses two EMA pairs. A Buy is triggered by EMA (11) crossing above EMA (47). A Sell is triggered by EMA(21) crossing below EMA (55). Beisiegel cites great backtesting results, but in practice both Buy and Sell signals have a huge lag.

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Option-based Systems

3. TOF Ratio Live Link

Long-time message board regular The Old Fool, aka TOF (Richard McRanie), was the first person I observed using this indicator. The TOF Ratio divides the NASDAQ by the CPC, and Buy and Sell signals are triggered by EMA (21) crossovers above and below EMA (50). Historically, the first negative crossover is a warning shot; the second negative crossover triggers the Sell. This is a clever indicator with a long history of accurate market signals.

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4. CPCE Ratio Live Link

The put/call ratio was developed by Marty Zweig in the early 1970's. In recent years, Zweig has questioned the usefulness of the CPC as a contrarian indicator due to distortions in index option activity from hedging activities. Zweig now favors the CPCE in these types of calculations, a sentiment widely shared by the technical community.

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5. BPI Ratio Live Link

Message board regular hari_seldon at Clearstation is the first person I noticed divide the Bullish Percentage Index by the CPCE. The BPI's are breadth metrics that track the percentage of stocks printing bullish Point & Figure charts. Seldon uses the raw ratio data for his triggers, and this data can be noisy, triggering false signals at both ends of the range.

Filtering the noise with moving averages and watching for crossovers produces useful signals. The chart below uses the NDX BPI, and EMA (21) crossovers above and below EMA (50) serve as the Buy/Sell triggers. Like the TOF Ratio, the first negative crossover is a warning shot; the second negative crossover triggers the Sell.

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Volatility Systems

6. VIX Timing System Live Link

Bill Luby posted about the VIX Timing System, which is in itself based on a Credit-Suisse VIX study. The MarketSci sounds (and looks) complicated, but in practice it's quite simple. Backtesting reveals that it's also very reliable, but it has a tendency to keep investors out of profitable trades.

Buy the S&P 500 when:
---- (a) the 11-day SPX EMA (red) is below the 11-day SPX SMA
---- (b) the 11-day VIX EMA (purple) is above the 11-day VIX SMA.
---- Exit the position when either of the two conditions above are not met.

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7. VXN Timer Live Link

My preferred volatility timer simply divides an index (NASDAQ, SPX, INDU, RUT) by its volatility metric (VXN, VIX, VXD, RVX, respectively). Smooth the data with EMA's, and watch for EMA(21) crossovers above and below EMA(50). Below is the NASDAQ:VXN.

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8. RSI Live Link

The Relative Strength Index (RSI) was developed by J. Welles Wilder in the 1970's, and like moving averages, you can't talk about timing systems without mentioning RSI.

Trading Markets has a good RSI timer overview, and both Bill Rempel and David at The Shark Report are dedicated practitioners of the most common version, RSI (2). There are countless variations, but in its simplest form: Buy when RSI(2) falls below 10; Sell when RSI(2) rises above 90. Note on the chart below that this "strict" version would have kept you out of many profitable trades.

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9. Nocona Live Link

iHub regulars are familiar with Nocona's Early Retirement System. Nocona is based on CCI(100), and there are many variants. In it's original form, a Buy is triggered by a move above CCI +100; a Sell (short) is triggered by a move back below CCI +100. Once short, you hold short until CCI breaks back above -100, at which time you cover and go long.

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Bill said...

The Shark Report ( is a much more consistent user of 2-day RSI than I am. Usually I'm using it only to get levered up for quick hits.

dk said...

Bill...thanks for jogging my memory about David at The Shark Report. I've updated the post.

Addendums aside, your ongoing discussions of RSI(2) are worthy, and I've enjoyed watching you work through this indicator.

John Claydon said...

Hi dk. I like your blog. But in general I find your charts hard to read. Here is the 5-10-20 applied to ^GSPC -,e5,e20&a=m26-12-9,r14&c=

Much easier to read, I think.

And please take a look at my new blog and newsletter for small investors.


Anonymous said...

Hey DK...didn't hear from you re: 5-10-20 previous studies, but worked up my own research anyways. You can take a look at: Thanks, MS