How You Can Time The Market Successfully

Shmulik is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I always laugh when I hear people say that "you can never time the market." I believe that not only can you time the market, but that you should always time the market. By that I don't mean that you can time temporary ups and downs in individual stocks, that is a futile endeavor. What I mean is that you can spot general market trends, well in advance. There are times when you should be fully invested in equities, and there are times when you should be limiting your equity exposure. You can learn to identify these times by doing a little homework. The following are 3 different indicators that will assist you in recognizing future shifts in the stock market before they actually happen.

The indicators

Indicator #1: Inflow/outflow of funds: you can monitor the general flow of investor's money by looking which types of funds have raised the most money, and which ones have lost the most money. This signal serves as a counter-trend signal, meaning - you want to be invested in stock funds precisely when the investing crowd deserts stock funds and chases bond fund, etc. As of now, the Investment Company Institute recently reported strong money inflow to stock funds since the beginning of 2013.

Indicator #2: VIX: The volatility index, better known as the "fear index" measures the average volatility in stocks. In times of uncertainty, stocks jump all over the place, and the index gives a high reading. In times of complacency, the VIX is very low. It pays off to watch every time the VIX sits around its 52 week low, because this usually means that the investing crowd is too excited about stocks. We all know what happens once the general public gets too excited about stocks. As of now, the VIX gives a reading of 12.78, which is very close to the bottom of the 52 week range of 12.19 to 27.73.

Indicator #3: The 50 day moving average (DMA): As a general rule, you want to be invested in the stock market when less than 25% of all stocks are trading above their 50 DMA. This implies that the crowd is not too thrilled about stocks and that there is sufficient room for an upside. As of now, more than 93% of all stocks are trading above their 52 DMA. Historically, it has been a bad time to buy into stocks. 

The immediate suspects

When things turn for the worse, as I suspect will soon happen, there is usually a pretty well defined category of stocks that will get smacked in the head fast and hard, way before their peers. I am referring to the category of Internet - concept companies which trade at sky-high P/Es. If history is any guide, the stocks below will experience very sharp declines. Below is my “black list” of disastrous growth stocks:

  1. Amazon.Com (NASDAQ: AMZN): The gigantic Internet retailer is trading at an astounding P/E of 3,792x. It boasts a price/book of 15x. The company was able to increase its quarterly revenue by 22% year over year.
  2. Electronic Arts (NASDAQ: EA): the developer of game software and content is trading at a P/E of 1,573X. Its quarterly revenue growth has diminished by 13% year-over-year.
  3. Aspen Technology (NASDAQ: AZPN): The software optimization provider has a P/E of 1,530X and a Price/Book of more than 27X. The company's quarterly revenue growth jumped by more than 16% year-over-year.
  4. LinkedIn (NYSE: LNKD): The hub for social- professional networks has a P/E of 825 and a price/book of 16. The company demonstrated an impressive 80% growth in quarterly revenue.
  5. Netflix (NASDAQ: NFLX): The “video by mail” company is trading at a P/E multiple of 570 with a price/book of more than 12. The company exhibited quarterly revenue growth of only 8% year-over-year.

The Foolish bottom line

Based on the indicators I described above, we will probably be facing some tough times in the stock market soon. Staying away from stocks on my 'black list' is the preliminary step you can take in order to avoid catastrophic losses. You should try and time the market. It pays off handsomely. 

shmulikarpf has no position in any stocks mentioned. The Motley Fool recommends, LinkedIn, and Netflix. The Motley Fool owns shares of, LinkedIn, and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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