Analytical Toolbox: Introduction to Market Timing Models
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June 12, 2008
A market timing model generally uses a mix of indicators to identify bullish or bearish conditions for a specific financial market. In a basic model points are generated using each indicator’s current readings, which collectively provide bullish, bearish and neutral signals for the market monitored. As an example, a five indicator model may have a maximum potential point value of 6 with signals as follows:
- 4 or more points – bullish
- 3 points – neutral
- 2 or less points – bearish
The indicators selected for the model are not limited to the market monitored; interest rates may be used for a stock market model and the Dow Jones Utility Average for a bond model. The actual signals derived in market timing models are developed using past performance.
Ned Davis Research [NDR] and Martin Zweig are two names commonly seen when models are described, with many variations from the former referenced by other developers. The market classic Winning on Wall Street by Martin Zweig outlines indicators and models he’s used over the years for stock market analysis. One sample indicator in his core model is the Fed Indicator which uses changes in the discount rate or federal funds rate combined with changes in reserve requirements to generate points.
Zweig derived a point system to quantify the tendency for Fed changes to lead stock market turns—this is one edge the model employs. Other model developers may apply Fed changes indirectly by measuring changes in interest rates using Treasury bills, bonds and/or notes. The market timing model then uses changes in bond yield relationships as an edge in the stock market.
One major benefit of applying multiple indicators in a timing model versus keying in on individual indicators is that the model approach incorporates the dynamic nature of the market. Although history tends to repeat itself, it doesn’t do so in exactly the same manner. While financial stocks generally lead the broad stock market in bull markets, an upturn may not develop that way. An analyst focused on the strength of the financials may miss a newly evolving bullish move that develops coincident to (or before) a bullish move in this sector.
An individual that applies a market timing model uses a more flexible approach to analysis, allowing for bullish or bearish moves to occur in different environments. The model requires the bulk of the evidence to support a change in market conditions rather than requiring things to line up exactly as the did in the past. When a model developer combines a variety of well tested indicators, the stage is set for implementing systems and strategies best suited to conditions going forward.
To access other articles written by Clare White, please click here.
Clare White
Contributing Writer and Options Strategist
Optionetics.com ~ Your Options Education Site
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