Wednesday, March 4th, 2009...7:46 am
Making The Simplest Investing Rule Even More Simple
Last April, I highlighted Karl Denninger’s amazingly simple rule for ordinary long term investors. Using his rule, long term investors would have sold their stocks and moved to fixed income back in January 2008 when the S & P 500 was at 1350. From The Simplest Investing Rule:
His rule which he learned from his Chicago days is to compare the 20 Week Moving Average to the 50 Week Moving Average. When the 20 WMA passes the 50 WMA by 1%, you buy into an index fund. When the 50 WMA exceeds the 20 WMA by 1%, you sell your positions and move into a cash position or fixed income position.
For those interested in this rule and its historical effectiveness, watch this 8 minute video.
Last Friday I met a guy who had lost a lot of money in the market and was in near panic. Even though he personally felt the market was going to go lower, he was still fully invested. Being the swell guy I am, I told him about The Simplest Investing Rule.
Then I saw his puzzled look when I mentioned weekly moving averages. He didn’t even know what the S & P 500 was. As simple as Karl’s rule is, I thought I would attempt to make it even MORE simple. Here goes.
This should take about 1 minute. It should be done once a week.
- Visit the 50 Week vs 20 Week chart on StockCharts.com.
- Find the 50 Week Moving Average (red) and the 20 Week Moving Average (green) on the upper left hand side of the chart.
- Using a calculator and the division key determine if either number exceeds the other by more than 1%. When the MA 20 exceeds the MA 50 by more than 1%, buy back into the market. When the MA 50 exceeds the MA 20 by more than 1%, sell your stocks and move into fixed income.
If you need help with the division, read How to Find a Percentage of 2 Numbers.
There you have it. You now can use The Simplest Investing Rule to manage your money. You will never catch the absolute bottom and you won’t get out at the very top, but you will participate in bull markets and be protected in bear markets.
* DISCLAIMER: Thankfully, I am not a certified financial planner.
12 Comments
March 4th, 2009 at 10:03 am
But does any “rule” still apply today when so many theories have just been tossed aside in this new environment. When I think about how my in-laws live in Ukraine, they maybe don’t have the perfect retirement but they control more variables. They own their own home, walk or take public transportation and grow 70% of their own food in a quarter acre plot of land.
The conclusion I’ve come to over these past years is an individual needs permanent capital. Preservation is first, upside is secondary. A portion of a monthly stream of income can be diverted to stocks but a person should be ready to lose 80% of funds put into stocks. No money that is needed for the next five years under any circumstance should be allocated to stocks. You’d think the telecom/tech bubble would have taught us that lesson.
If funds are needed even in ten years, then only half should be in stocks, otherwise there is a high probability the market cannot recover by the time the funds are needed.
A good portion of retirement funds can be in stocks if there is a 20 plus year time horizon.
I think the real key to this adjustment is that no matter how much money the government creates, inflation won’t return except for a few select commodities such as oil and potash.
The tendency to hoard funds during a crisis is too great. A real stimulus will require forced spending on high dollar value goods like cars, houses and dishwashers.
The government could give every tax paying family a $5000 check which only a manufacturer or home seller can cash but it would expire if not used within 90 days. Preferably this would be a one transaction per family affair.
It would be much better than pumping billions into banks and car manufacturers with nothing to see for it but billions in bonuses and payoffs to unions.
March 4th, 2009 at 10:38 am
“A good portion of retirement funds can be in stocks if there is a 20 plus year time horizon.”
I used to believe that. After reading Ed Easterling and John Mauldin, I now am more aware of the historical probabilities of expected returns based on WHEN that 20 year horizon starts.
http://www.frontlinethoughts.com/pdf/mwo022009.pdf
http://www.crestmontresearch.com/content/Matrix%20Options.htm
Karl’s rule recognizes these waves and does a better job of wealth preservation than most “financial planners” are capable of.
March 4th, 2009 at 11:34 pm
But MAS, what about these time proven strategies:
1) Buy and Hope
2) Dollar Lost Averaging
3) Random Walk …off a cliff
Kidding, of course…
March 6th, 2009 at 3:29 am
Even though he personally felt the market was going to go lower, he was still fully invested.
There is sound reason for this. There are a handful of days over a decade or more where the market moves up so much, that being out of it causes you to miss all the gains and reap all the losses. That’s a basic investing rule. Of course, if we knew when those days were, we’d all get in the day before and be multi-billionaires.
As for this theory, it’s a nice theory and all but one day, like all theories, it will stop working due to some paradigm shift we cannot fathom. If you think you are smart and plugged in enough, maybe you’ll even see it coming, but 99% of the rest of us won’t. At that point, we will lose a lot of money (either in real losses or because we were out of the market during a large upswing). We will then find a new theory but that money is gone.
Simply put, the market is a crap shoot where you’re trying to bet with the house. Even the house can lose sometimes. If you an stay in it for 50 years and dollar cost average, you’ll probably do OK but there is no guarantee. But yeah, 20 years is too short to get the odds all the way on your side. You can time it just wrong and get fleeced. That’s the best argument against privatizing SS that can be made.
March 6th, 2009 at 7:23 am
PB -
I probably should have added that the guy I talked to also felt (correctly) that the market was dishonest and they would uncover more fraud. Betting your retirement by investing in a game you perceive as rigged is probably not going to end well.
The Simple Rule is not about becoming a multi-billionaire. It is about minimizing exposure during common bear market conditions by hiding in fixed income. When your financial planner is wrong, you lose money. When this rule is wrong, you just don’t maximize your potential gain.
This is a defensive strategy for those that don’t understand or don’t care to understand the market.
Ed Easterling’s research discusses probabilities of expected returns based off history. Denninger’s rule is a simplified application of those statistics.
March 6th, 2009 at 12:25 pm
PB – No offense, but I could quite tell what your point was.
- If the point was that you should never buy equities, then where should you put your money?
- If the point was to support a “buy and hold” methodology, then “sold to you!”
Seriously though, you gotta put your money somewhere. The goal should be to reduce downside risk, which is what MAS’s (Denninger’s) method does.
Another popular method is to buy when PEs are low (25). This has a similar positive effect on an equity portfolio.
Finally, the largest daily gains are allways in bear markets (in bear rally’s). Not a good time to be “in,” since prices eventually roll over and drop even further.
March 6th, 2009 at 12:28 pm
Typo: Another popular method is to buy when PEs are low (25).
Should have been: Another popular method is to buy when PEs are low (below 12)and sell when they are high (above 25).
Note: I used greater than and less than signs in the parenthesis and forgot that it would read it as html …Doh!
August 6th, 2009 at 6:42 pm
This indicator appears to be ready to trigger within the next few weeks or so. Buying?
August 6th, 2009 at 9:19 pm
I think this is a parabolic blow off in progress.
http://sites.google.com/site/sp500pejuly2009/
August 6th, 2009 at 11:57 pm
We might hit 1200 on the S&P, but I still think it is a bear rally. Every move tends to correct 1/3 to 2/3 the prior move …and we just saw a historic plunge.
In technical analysis, we appear to be creating the A of an MA pattern that started forming in the mid 90s. You don’t want to know the target…
http://www.youtube.com/watch?v=Y6FzvWjQ_A0
August 7th, 2009 at 7:28 am
I love Steely Dan and agree with Jim’s analysis.
In the Eye of the Hurricane post I listed 2 conditions I would need to believe in the recovery. Neither has occurred.
August 10th, 2009 at 3:42 pm
Nate did a great post on this topic today.
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