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Only rank amateurs try to time the market.

It's impossible. No one can do it other than through pure luck. Market-timers aren't investors, they're gamblers. If you want to succeed at investing, focus on the "long term" and put your trust in a safe and secure mutual fund with a "long-term" record of superior performance.

Or at least that's what the mutual funds say.

And they've been saying it for so many years (they hit their stride in '94) that it has become an article of faith. Forget that only a handful of funds outperform the market averages each year. Forget that funds have been able to ignore 1987 in their 10-year track records for some time now (and in a year, they can drop '00 from their 5-year). Forget that -- their protestations to the contrary -- they are often proclaiming in ponderous tones that the market is "overbought" or "oversold", that they wouldn't buy ACME "here" because it's "overpriced", but that they'd buy it "there" because that would be a "real buying opportunity". When they are not being "cautious" or "standing on the sidelines", they are beating drums, banging on tables, backing up trucks. But only rank amateurs try to time the market.

The fact is that market timing is not all that difficult.

In fact, if you can plot a point on a graph and tie your own shoes, you can time the market. Even those whose VCR clocks are still blinking can time the market. The Long Term Buy and Hold contingent (the LTBH) will assure you that it can't be done because (a) they've been listening to the funds for all these years, (b) they don't know how to do it, and (c) they don't really care enough about it to want to learn how to do it even if they could be convinced that it could be done. All things considered, they'd rather spend the time with their spouses or children or houseboys. Or read a book. Or hitchhike through Europe. (There is also probably an LTBH subset that believes that if they don't know how to do something, it's not worth doing. Or if they haven't been somewhere, it's not worth going. Or if they haven't seen something, it's not worth seeing. But they generally belong to the NRA and have their money buried in the backyard, so their skepticism won't be addressed here.)

This is not to say that just anyone can pick the absolute top and the absolute bottom.

That truly is virtually impossible except on an occasional basis, but even then it's more likely to be the result of chance and not of any particular genius or skill. But one can get pretty damn close to the bottom and/or the top, enough to make the effort more than worthwhile. And even a confirmed LTBHer who believes beyond all reason the LTBH mantra must admit in those rare flashes of lucidity that he wishes he had sold ACME at 180 after buying it at 150 rather than hold it all the way down to 14.

To illustrate this point, the following table shows the results of a study done several years
ago by CDA (now Thomson Financial)/ Weisenburger:

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Perfect Market Timing vs Perfect Sector Timing vs Buy & Hold

Year 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 Jul-96

Buy & Hold $1,000 1,017 1,236 1,514 1,607 2,117 2,642 3,077 4,049 3,922 5,116 5,504 6,058 6,135 8,432 8,873

Market Timing $1,000 1,627 2,018 2,438 3,407 4,408 6,691 8,197 10,786 12,618 16,456 17,707 19,489 21,319 29,303 30,836

Sector Timing $1,000 1,403 1,782 2,088 2,940 3,808 5,185 6,189 8,526 9,759 16,119 21,925 39,489 44,376 65,498 73,677

The perceptive reader will notice, of course, that the headers refer to "perfect" timing. This is attainable only through hindsight as one must be able to pick the exact top and the exact bottom for the year under consideration. But the differences between buy-and-hold and perfect timing are so dramatic that all but the most skeptical must admit that even if one were to come within only ten or fifteen percent of the top or bottom that his results would be far superior to those of a buy-and-hold strategy.

exercise if one is in the market for no other reason than to be "in the market". But only the pathological are in the market to lose money. The rest are in the market to make money, that is they want their stocks to go up, not down. They want to participate in the upside, but truth be told would prefer not to participate in the downside. The LTBH contingent will again declaim that the one is not possible without the other, that one pays his money and takes his chances, but thinking about market timing as nothing more than another form of risk management can help to chip away at this steely opposition, "risk management" being defined as maximizing one's participation in the upside and minimizing his participation in the downside. The thoroughly-converted LTBHer who would rather be dragged screaming than to entertain the notion of market-timing (or risk management) may now drag out the old LTBH chestnut about how being out of the market during its 40 Best Days or whatever over whatever period of time would slash one's results to ribbons. However, missing the 40 Best and Worst days during the period from 1980 to 1989 -- during which time the S&P 500 returned an average of 17.6% -- would have increased one's return to 21.3%. According to Sosnowy:
In order to be a successful risk management investment strategy, market timing does not have to be perfect. Despite belief to the contrary, market timing does not target getting in and out of the market at the absolute bottoms or tops. It does, however, strive to get an investor's funds out of the market before a major bear market devastates the portfolio. Market timing's first and foremost priority is the preservation of capital.

Timing the market (or the sector) for the sake of timing the market is largely a pointless

The purpose of this file, however, is not to provide a catalogue of the statistical birdies that market timers and LTBHers lob at each other whenever this subject is introduced; it is to examine the conditions under which market timing is possible.

There are any number of market-watchers -- technicians and fundamentalists alike -- who

employ all sorts of "indicators" to tell them what the market is going to do or is likely to do, or which will at least give them a sense of the "health" of the market. They'll look at what percentage of stocks are above or below some moving average or other, how the cosine of the volume relates to the cube root of the closing price (undiluted), where "investor sentiment" is running (which tells one only what investors say they're thinking, not what they are actually doing in terms of buying and selling), who's buying puts (or calls) and where and when and how many, how the slow stochastic confirms (or not) the fast RSI or the MFI or the OBV or the QED.

None of this, however, is really necessary.

And since none of these indicators will tell you what you want to know, they are not even desirable. They can, in fact, persuade you to do exactly the opposite of what you ought to be doing.

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Assuming that you've read and understand the Demand/Supply file and the nature of

distribution and accumulation, there are only a few other items which you need to know in order to arrive at a few reliable conclusions regarding the likelihood of a top or bottom in the market, and you don't need an expensive charting program in order to track them. The first of these items is the volume of advancing issues and the volume of declining issues.

There are at least three advantages to using this data.

The first is that the data is readily available for nothing to anyone anywhere who takes the time to look for it. The second is that you don't have to rely on complex formulas or the esoteric interpretations of "experts" to tell you what's right in front of you -- the data is "raw". The third is that you don't have to do much if any interpretation of your own; if you understand up, down, confirmation, and divergence, you're in.

TOPS
The eagle-eyed timer is always on the lookout for distribution.
You'll recall from the Demand/Supply file that distribution takes place during the "topping" process (what Weinstein calls "Stage 3), after the mark-up stage ("Stage 2"), and that it peeks out of its hole when one detects an increase in volume with little or no upside in price (granted that "increase" and "little or no" hardly qualify as scientific definitions, but interpreting charts requires a little interpretation). In the example below (a slice of the Nasdaq from January '97 to December '98), the first such week is the third week in April '98. Volume is the highest in this four-month leg, and the second-highest in this timeframe to this point, but the effect on price is practically nil, with the week closing at its low.

A second and more "bonk"-style signal is provided the third week of July '98. Note how price rises nicely, at its high for the week, on pretty good volume. However, the following week, price drops decisively, below the low of the second week. Novices (and some out-of-touch "expert" perma-bulls) will look on this favorably, since the up volume was higher than the down volume. The market psychologist, however, will understand that the decisive move down represents big-time failure on the part of the bulls, and that he better pay attention.

A view of the daily chart underlying these two periods illuminates and confirms the points

made regarding distribution. Regarding the first, note that the highest volume during that third week of April is also the highest price point. However, that bar is hardly a ringing endorsement, closing as it does well below its high. That in and of itself, of course, is not enough. One can find many such bars that don't necessarily mean much. But the following downbar sends a clear signal that something is up.

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As for the second period, in July, the volume here actually trails off before the high. Again, this, in and of itself, is not necessarily critical; volume needn't track price point for point each step of the way. But look at the price bars, how difficult it is for them to progress, the closing at or near the open each day, the final bar with the open equalling the close exactly in the middle of the bar. Given how the volume is backing away, this sends a message that the buying is becoming exhausted. And the seriousness of that exhaustion is made clear by the rapidity and severity of the subsequent decline.

The sharp reader may have detected a small pothole in this scenario by now, which is the

fact that, in any bull run, one is going to find plenty of days when volume is pretty impressive and the upside in price is not what one might expect. And yet the after-effects are nil. Does one hoard bottled water and put up the storm windows anyway even though it may all be a waste of time? Everyone knows the fallout from crying "wolf" too often. How does one know whether the distribution is simply a thin cloud passing over the sun or a portent of imminent pestilence and famine? The average did, after all, advance to new highs just a few weeks later.

the AV-DV Differential

Everybody knows what advancers and decliners are, but the differential between

advancing volume and declining volume is not as well known, perhaps because it's so simple that anyone can understand it and no interpretation is required of high-priced analytical "talent".

The significance of the difference between advancers/decliners and the volume of each has

to do with the nature of advancing and declining volumes themselves as opposed to measures of the numbers of advancing and declining issues alone. The numbers of advancing and declining issues tell one how many stocks are going up and how many stocks are going down. The volume of advancing and declining issues, however, tells one something of the demand for stocks (or lack of it). If one calculates the difference between the volume of advancing issues and the volume of declining issues over time (or goes to StockCharts.com for as long as they're in business and enters $NAUD or $NYUD), he has a very simple measure of the true demand for stocks as evidenced by actual trades. When the differential rises, the volume of advancers is outpacing the volume of decliners. When the differential falls, the opposite is the case.

The chart below shows a 5-day moving average of this differential (done to "smooth" out
the spikiness, but averaging the points is not an essential step):

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The weekly chart provided earlier is repeated here for ease of comparison.

Note also that even though the above chart is "daily", the timeframe encompassed by the two charts is the same.

How to use the AVDVd to confirm (or not) distribution?

Look again at our first point, in April '98. Note what's happening with the AVDVd line "a-b". Even though price is making a higher high, the AVDVd is actually making a lower high, a pre-bonk, a yellow light, a "divergence". Now look at our next period in July, an even higher high. What's happening with the AVDVd line "c-d"? Yep, a lower low, a full bonk, a red light, another "divergence". Now one could argue that price did in fact eventually take off for new horizons (we all know what happened in '99-'00), so selling would have meant missing out on all those gains. Point one, however, is that price dropped 500 points, with no guarantee that it would stop there. But point two is that the AVDVd would have put you back in the market at very nearly the best possible time. Aside from the fact that waiting until Friday of that week would show that a close at 1500 for the week suggested support from the last swing low in December/January, the AVDVd line "e-f" shows a dramatically higher low in October than in August. The AVDVd gets you out; the AVDVd gets you in.

And what about all those other lower highs and higher lows in the AVDVd, the ones that

I've conveniently ignored? Easy. They don't line up with price extremes. Unless price is showing off, the AVDVd line just putters along, sweeping up. After all, the volume of advancers can't beat the volume of decliners throughout a bull market. Otherwise, it would be off the scale. And, given the various fears and doubts and anxieties that plague market participants, that would be unrealistic anyway. You will note, however, that the AVDVd does spike in March '97 and never reaches that level again, even though price wends its merry little way up. At the very least, this serves to prevent the 15% pullback at the end of '97 from being a big shock. I mean, it isn't as if you weren't warned.

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Next? Earlier I said that other than an understanding of the distribution/accumulation process,
there were a few other items that would be helpful in spotting tops and bottoms, the first of which was the AVDVd. If you have studied the distribution/accumulation cycle and you've studied the AVDVd and you feel that your grasp of these tools is still a bit limp, you can also apply what you've learned about trendlines to this process. The chart below depicts the Nasdaq trends from the point it began to accelerate in the mid-nineties (largely due to mutual funds, the wider acceptance of the PC, the development of Windows and the Netscape browser, the launch of AOL, discount brokerages, online trading, and the availability of reasonably-priced charting programs). Note the three stages illustrating acceleration:

I'll assume that you've studied the Trendlines 101 file and don't need to be told what all this means. But even if you haven't, you can see that the TL break alone, in August '98, signals trouble. Combined with the information provided by the AVDVd, it confirms it.

Want more? (Damn!) How 'bout moving averages?

These are, after all, only moving trendlines. Applied to the same chart, below, they come within a hair of crossing with each pullback, but they don't scream at you until they signal the real trouble (these are 10 and 40-week MAs, comparable to 50 and 200-day MAs):

You'll note, of course, that waiting for this third confirmation of your initial suspicions would not get you out until the last week of September, and waiting so long might make jumping back in again in October that much more difficult. After all, you just sold and now you feel like a chump. But that's the price paid for addtional confirmations, and the greater amount of time it takes to receive them. If you want to make more money (or save it), you sometimes have to be a bit quicker at stepping off the curb.

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I don't mean to give the impression from the above comments that one ought to be selling

everything he has as soon as "the market" begins to smell bad. To the contrary, pre-emptive selling (selling before the stock has actually reached whatever stop has been placed under it) can be an expensive error, particularly if the stock in question turns out to be one of those rare birds that soars in a down market. But one can at the very least re-evaluate the placement of his stops, consider selling his weakest positions, consider selling portions of those stocks in which he's profited the most. He will thus have the cash to take advantage of opportunities which probability suggests will occur in the near future. And he will have made all these preparations within 10-15% of the top.

Bottoms
Finding and exploiting the bottom is substantially easier than making the most out of tops,
largely because one has a significant cash position, and it's always easier to take a relaxed and objective view of the landscape when one isn't called upon to do anything about it.

What appears to be the "bear market bottom" (at least for now, in '04) is especially useful
as an illustration of how all of this can work to the investor's benefit. The trials and tribulations of '00, '01, and '02, including 9/11, are now familiar to everyone, whether market participant or not.

Here, we're looking not for evidence of distribution (an appalling number of people, of

course, have been looking for confirmation of distribution all the way to '04), but of accumulation, and that means a base. Even if you did nothing more than look for this base, doing so would have kept you out of the '00 rally, since a 1000-point range is not what one would call "narrow", regardless of the circumstances.

The first of what one might reasonably call a "base" occurs in the spring of '01.

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Now this base running from mid-April '01 to August is really a pretty nice little base. It lasts for nearly four months (which isn't much given the 3000-point decline, but it beats a few weeks), the 500-point swings seem to be over, the bars tighten up, the lateral movement stabilizes (which is, after all, required of a base). When there's a test of buying interest in May, the price doesn't go anywhere, but when there's a subsequent test of selling interest in June, that doesn't go anywhere, either, which is a big plus. Volume then declines, and price gets even quieter, both of which are, again, a big plus. However, price falls out of this base in August, long before 9/11 (unless somebody knew something). So something more is required. Let's look, then, as above, to the AVDVd.

Note here that the AVDVd gives the thumbs-up on that base as well (line "a-b"); April is higher than December; there's a divergence; selling is slowing; a base forms. But, as stated above, the base still fails. So even the AVDVd isn't enough. So we move on to trendlines (we'll be coming back to this chart, though, to explore the ins and outs of those other notations, so shove it under the backstairs of your mind for the time being).

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Unfortunately, though this has to be done, the trendlines are of no help either. In fact, since that base breaks TL1, that gives added confidence to the investor who thinks this may be the bottom (that bump up the previous August is ignored since the price ducked back under the TL so quickly). When 9/11 occurs, TL2 can be drawn, and that is very quickly broken, but we're still not at the bottom. But a lower low the following year allows TL3 to be drawn, and we know, having reached the third stage, that we are at least closer.

So now we move on to the fourth step, the moving averages, and here at last we achieve
some clarity:

Here we get something that helps prevent us from shooting ourselves in the foot. Remembering that MAs are just another form of trendline, note that the shorter MA is below the longer MA all the way from June '00 to Jan '02. Therefore, regardless of whatever else is going on with bases and the AVDVd and traditional trendlines, you're out. Case closed. Let's pull the AVDVd chart out from under the backstairs, then, and see step by step how the MAs help us avoid disaster (or, in spite of themselves, occasionally help us dig our hole).

Going back to June '00, note that the AVDVd gives you permission to re-enter the market

(if you ever left) by following line "e-f". And an awful lot of people did just that, so if you were one of them, you had lots of company. By the beginning of July, however, the shorter MA is clearly below the longer. Big yellow light. Now we make a higher high (at least, higher than the high established the first week of May). And volume ain't bad. And the shorter MA even begins to rise. Only problem is the AVDVd is diverging (line "g-h") But we decide to stand pat, and stand watch. Unfortunately, the next attempt to move higher, in August, is paired with an AVDVd that is even lower. This, plus the falloff in volume, plus that big, dark bar the next week, in September, plus the fact that the shorter MA can't pull itself back up above the longer (meaning that short-term buying pressure is no match for longer-term selling pressure), ought to be enough for anybody (at least one can exit with a profit).

Another opportunity doesn't arise, i.e., satisfy all these tests, until more than a year later,
in January '02, and, yes, depending on one's strategy, one might have been persuaded to buy at this point, even though at the time the shorter MA crosses above the longer, the price is declining (this is more obvious on the daily chart). And if one remembers, again, that these MAs are just moving trendlines of buying and selling pressure, not anything magical, he may not be quite so eager to jump in simply because one crosses another. If, however, he jumps in anyway, it doesn't turn sour so quickly that he can't get out with more than a small loss.

Next opportunity?

Not "the bottom" in October '02 (though it would be perfectly okay to buy there if one can tolerate the risk), but several months later. The following is presented in order to provide you with a context.

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The "boxed" area, from July '01 through July '03, is presented in the chart below:

Transferring all the information just provided to this one chart, we get the following picture:

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Again, one could buy in October on the basis of the trendline break and the AVDVd divergences (in a nutshell, the volume of decliners is not what one would expect it to be, given the decline in price). One might also note the lower volume accompanying the October low than that which accompanies the July drop, suggesting that selling is becoming -- or is -- exhausted. The MA cross in April, however, is a little extra insurance, and waiting for this final piece to slip into place would mean giving up very little.

The Fly in the Ointment

In a more perfect world, I could exit here and leave you to your charts and your

spreadsheets. But the real world isn't seamless. Sometimes all the markets -- the Dow, the NYSE, the Nasdaq, and the S&P 500 -- all move in tandem, and making money is as easy as finding a T-shirt shop on Fisherman's Wharf. But sometimes they don't move in tandem, as in early 2000, and the investor is required to exercise judgement as to the most appropriate course of action (it is because of this often-required need to exercise judgement that the value of technical analysis can't be "tested", and that chart interpretation becomes as much art as science). For this reason, those who see something here that they believe may be of value to them should plot a series of NYSE charts to match the Nasdaq charts above (the NYSE is the only other average to provide this AVDV data, though one could compile it for the DJIA himself if he really wanted to) and go through this exercise again in order to better anticipate potential potholes in future analyses of AVDV data.

So Now What Do I Do? Those who are always looking ahead may have noticed that the differentials sometimes
suggest that perhaps the rally or pullback/correction will be short-lived. But, again, it is characteristic of this data that it is of value only at extremes, i.e., during those periods when the market is at what appears to be unsustainable highs or unsustainable lows. The question that must be answered during any prolonged movement up or down must be whether everything is acting in concert. If, for example, the market averages are making ever-higher highs, is the AV keeping pace or does it seem to be tiring? One must remember, again, that the differential will not track the price plot like a cheap detective every single day of the advance. People will take profits, after all, and prices do pull back. However, any attempt by price to make a new high (or low, as the case may be) after a pullback or correction which is accompanied by a divergence in the differential is worth attending to, and should move the investor at least to DEFCON3 (a position of wariness, for our foreign readers).

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We left our tale of tops, earlier, in October '98.

But there were 18 months to go before the market flew so near the sun that the wax in its wings began to melt and it plummeted to earth. Regarding only the AVDVd, '99 was not a particularly volatile year, at least until November. There were a few minor divergences between the AVDVd and price, but they had more to do with lack of confirmation than serious divergence. Any doubts as to what to do could be eased by the use of TLs and MAs, the opposite of what was demonstrated above in reference to the voyage down.

You'll recall that the shorter MA dropped below the longer in June '00. In March, however, the AVDVd was showing a much more serious divergence than it had in over a year. But even if one had held on through the trendline break in April and the MA cross down in June, the dramatic divergence in the AVDVd from June to July should have persuaded even the most hopeful that the Nasdaq had in fact struck an iceberg and was rapidly taking on water.

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