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Only rank amateurs try to time the market. It's impossible. No one can do it other thanthrough pure luck. Market-timers aren't investors, they're gamblers. If you want tosucceed at investing, focus on the "long term" and put your trust in a safe and securemutual 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 ahandful of funds outperform the market averages each year. Forget that funds have beenable to ignore 1987 in their 10-year track records for some time now (and in a year, theycan drop '00 from their 5-year). Forget that -- their protestations to the contrary -- theyare 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 agraph and tie your own shoes, you can time the market. Even those whose VCR clocks arestill blinking can time the market. The Long Term Buy and Hold contingent (the LTBH) willassure you that it can't be done because (a) they've been listening to the funds for all theseyears, (b) they don't know how to do it, and (c) they don't really care enough about it towant to learn how to do it even if they could be convinced that it could be done. All thingsconsidered, they'd rather spend the time with their spouses or children or houseboys. Orread a book. Or hitchhike through Europe. (There is also probably an LTBH subset thatbelieves that if they don't know how to do something, it's not worth doing. Or if theyhaven't been somewhere, it's not worth going. Or if they haven't seen something, it's notworth seeing. But they generally belong to the NRA and have their money buried in thebackyard, 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. Thattruly is virtually impossible except on an occasional basis, but even then it's more likely tobe the result of chance and not of any particular genius or skill. But one can get prettydamn close to the bottom and/or the top, enough to make the effort more thanworthwhile. 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 180after 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 yearsago by CDA (now Thomson Financial)/ Weisenburger:

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Perfect Market Timingvs

Perfect Sector Timingvs

Buy & Hold

Year Buy & Hold Market Timing Sector Timing

198119821983198419851986198719881989199019911992199319941995

Jul-96

$1,0001,0171,2361,5141,6072,1172,6423,0774,0493,9225,1165,5046,0586,1358,432

8,873

$1,0001,6272,0182,4383,4074,4086,6918,197

10,78612,61816,45617,70719,48921,31929,303

30,836

$1,0001,4031,7822,0882,9403,8085,1856,1898,5269,759

16,11921,92539,48944,37665,498

73,677

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

Timing the market (or the sector) for the sake of timing the market is largely a pointlessexercise if one is in the market for no other reason than to be "in the market". But only thepathological 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 willagain declaim that the one is not possible without the other, that one pays his money andtakes his chances, but thinking about market timing as nothing more than another form ofrisk management can help to chip away at this steely opposition, "risk management" beingdefined as maximizing one's participation in the upside and minimizing his participation inthe downside. The thoroughly-converted LTBHer who would rather be dragged screamingthan to entertain the notion of market-timing (or risk management) may now drag out theold LTBH chestnut about how being out of the market during its 40 Best Days or whateverover whatever period of time would slash one's results to ribbons. However, missing the40 Best and Worstdays during the period from 1980 to 1989 -- during which time the S&P500 returned an average of 17.6% -- would have increasedone's return to 21.3%.According to Sosnowy:

In order to be a successful risk management investment strategy, market timing does not have tobe perfect. Despite belief to the contrary, market timing does not target getting in and out of themarket at the absolute bottoms or tops. It does, however, strive to get an investor's funds out ofthe market before a major bear market devastates the portfolio. Market timing's first and foremost

priority is the preservation of capital.

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

There are any number of market-watchers -- technicians and fundamentalists alike -- whoemploy 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 whatpercentage of stocks are above or below some moving average or other, how the cosine ofthe volume relates to the cube root of the closing price (undiluted), where "investorsentiment" is running (which tells one only what investors say they're thinking, not whatthey are actually doing in terms of buying and selling), who's buying puts (or calls) andwhere and when and how many, how the slow stochastic confirms (or not) the fast RSI orthe MFI or the OBV or the QED.

None of this, however, is really necessary. And since none of these indicators will tell youwhat you want to know, they are not even desirable. They can, in fact, persuade you to doexactly 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 ofdistribution and accumulation, there are only a few other items which you need to know inorder to arrive at a few reliable conclusions regarding the likelihood of a top or bottom inthe market, and you don't need an expensive charting program in order to track them. Thefirst 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 readilyavailable for nothing to anyone anywhere who takes the time to look for it. The second isthat 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 haveto do much if any interpretation of your own; if you understand up, down, confirmation,and divergence, you're in.

TOPSThe eagle-eyed timer is always on the lookout for distribution. You'll recall from theDemand/Supply file that distribution takes place during the "topping" process (whatWeinstein calls "Stage 3), after the mark-up stage ("Stage 2"), and that it peeks out of itshole 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 chartsrequires 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, butthe 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 howprice rises nicely, at its high for the week, on pretty good volume. However, the followingweek, price drops decisively, below the low of the second week. Novices (and someout-of-touch "expert" perma-bulls) will look on this favorably, since the up volume washigher 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 betterpay attention.

A view of the daily chart underlying these two periods illuminates and confirms the pointsmade regarding distribution. Regarding the first, note that the highest volume during thatthird week of April is also the highest price point. However, that bar is hardly a ringingendorsement, closing as it does well below its high. That in and of itself, of course, is notenough. One can find many such bars that don't necessarily mean much. But the followingdownbar 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 i tself, is not necessarily critical; volume needn't track price point for pointeach step of the way. But look at the price bars, how difficult it is for them to progress, theclosing at or near the open each day, the final bar with the open equall ing the close exactlyin the middle of the bar. Given how the volume is backing away, this sends a message thatthe buying is becoming exhausted. And the seriousness of that exhaustion is made clear bythe rapidity and severity of the subsequent decline.

The sharp reader may have detected a small pothole in this scenario by now, which is thefact that, in any bull run, one is going to find plenty of days when volume is prettyimpressive and the upside in price is not what one might expect. And yet the after-effectsare nil. Does one hoard bottled water and put up the storm windows anyway even thoughit 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 ora portent of imminent pestilence and famine? The average did, after all, advance to newhighs just a few weeks later.

the AV-DV Differential

Everybody knows what advancers and decliners are, but the differential betweenadvancing volume and declining volume is not as well known, perhaps because it's sosimple that anyone can understand it and no interpretation is required of high-pricedanalytical "talent".

The significance of the difference between advancers/decliners and the volume of each hasto do with the nature of advancing and declining volumes themselves as opposed tomeasures of the numbers of advancing and declining issues alone. The numbers ofadvancing and declining issues tell one how many stocks are going up and how manystocks are going down. The volume of advancing and declining issues, however, tells onesomething of the demandfor stocks (or lack of it). If one calculates the difference betweenthe volume of advancing issues and the volume of declining issues over time (or goes toStockCharts.com for as long as they're in business and enters $NAUD or $NYUD), he has avery simple measure of the true demand for stocks as evidenced by actual trades. Whenthe differential rises, the volume of advancers is outpacing the volume of decliners. Whenthe differential falls, the opposite is the case.

The chart below shows a 5-day moving average of this differential (done to "smooth" outthe 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 thateven though the above chart is "daily", the timeframe encompassed by the two charts isthe same.

How to use the AVDVd to confirm (or not) distribution? Look again at our first point, inApril '98. Note what's happening with the AVDVd line "a-b". Even though price is makinga 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 happeningwith 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 knowwhat 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 stopthere. 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 weekwould show that a close at 1500 for the week suggested support from the last swing low inDecember/January, the AVDVd line "e-f" shows a dramatically higher low in October thanin 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 thatI've conveniently ignored? Easy. They don't line up with price extremes. Unless price isshowing off, the AVDVd line just putters along, sweeping up. After all, the volume ofadvancers can't beat the volume of decliners throughout a bull market. Otherwise, it wouldbe off the scale. And, given the various fears and doubts and anxieties that plague marketparticipants, that would be unrealistic anyway. You will note, however, that the AVDVddoes spike in March '97 and never reaches that level again, even though price wends itsmerry little way up. At the very least, this serves to prevent the 15% pullback at the endof '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 ofwhich was the AVDVd. If you have studied the distribution/accumulation cycle and you'vestudied the AVDVd and you feel that your grasp of these tools is still a bit limp, you canalso apply what you've learned about trendlines to this process. The chart below depictsthe 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 theNetscape browser, the launch of AOL, discount brokerages, online trading, and theavailability of reasonably-priced charting programs). Note the three stages illustratingacceleration:

I'll assume that you've studied the Trendlines 101 file and don't need to be told what allthis 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 movingtrendlines. Applied to the same chart, below, they come within a hair of crossing with eachpullback, 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 suspicionswould 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 nowyou feel like a chump. But that's the price paid for addtional confirmations, and the greateramount of time it takes to receive them. If you want to make more money (or save it), yousometimes 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 sellingeverything 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 beenplaced under it) can be an expensive error, particularly if the stock in question turns out tobe one of those rare birds that soars in a down market. But one can at the very leastre-evaluate the placement of his stops, consider selling his weakest positions, considerselling portions of those stocks in which he's profited the most. He will thus have the cashto 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.

BottomsFinding 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 relaxedand 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 usefulas an illustration of how all of this can work to the investor's benefit. The trials andtribulations of '00, '01, and '02, including 9/11, are now familiar to everyone, whethermarket participant or not.

Here, we're looking not for evidence of distribution (an appalling number of people, ofcourse, have been looking for confirmation of distribution all the way to '04), but ofaccumulation, and that means a base. Even if you did nothing more than look for thisbase, doing so would have kept you out of the '00 rally, since a 1000-point range is notwhat 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 afew weeks), the 500-point swings seem to be over, the bars tighten up, the lateralmovement stabilizes (which is, after all, required of a base). When there's a test of buyinginterest in May, the price doesn't go anywhere, but when there's a subsequent test ofselling interest in June, that doesn't go anywhere, either, which is a big plus. Volume thendeclines, and price gets even quieter, both of which are, again, a big plus. However, pricefalls out of this base in August, long before 9/11 (unless somebody knew something). Sosomething 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 ishigher than December; there's a divergence; selling is slowing; a base forms. But, asstated above, the base still fails. So even the AVDVd isn't enough. So we move on totrendlines (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 maybe the bottom (that bump up the previous August is ignored since the price ducked backunder the TL so quickly). When 9/11 occurs, TL2 can be drawn, and that is very quicklybroken, but we're still not at the bottom. But a lower low the following year allows TL3 tobe 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 achievesome 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 isbelow the longer MA all the way from June '00 to Jan '02. Therefore, regardless ofwhatever 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 stepby step how the MAs help us avoid disaster (or, in spite of themselves, occasionally help usdig 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 youwere one of them, you had lots of company. By the beginning of July, however, the shorterMA 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 theshorter MA even begins to rise. Only problem is the AVDVd is diverging (line "g-h") Butwe 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, plusthat big, dark bar the next week, in September, plus the fact that the shorter MA can't pullitself back up above the longer (meaning that short-term buying pressure is no match forlonger-term selling pressure), ought to be enough for anybody (at least one can exit with aprofit).

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 tobuy at this point, even though at the time the shorter MA crosses above the longer, theprice 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 anythingmagical, 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 withmore than a small loss.

Next opportunity? Not "the bottom" in October '02 (though it would be perfectly okay tobuy there if one can tolerate the risk), but several months later. The following is presentedin 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 followingpicture:

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Again, one could buy in October on the basis of the trendline break and the AVDVddivergences (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 theOctober 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, andwaiting 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 yourspreadsheets. 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 aseasy as finding a T-shirt shop on Fisherman's Wharf. But sometimes they don't move intandem, as in early 2000, and the investor is required to exercise judgement as to the mostappropriate 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 chartinterpretation becomes as much art as science). For this reason, those who see somethinghere that they believe may be of value to them should plot a series of NYSE charts to matchthe 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 thisexercise again in order to better anticipate potential potholes in future analyses of AVDVdata.

So Now What Do I Do?

Those who are always looking ahead may have noticed that the differentials sometimessuggest that perhaps the rally or pullback/correction will be short-lived. But, again, it ischaracteristic of this data that it is of value only at extremes, i.e., during those periodswhen the market is at what appears to be unsustainable highs or unsustainable lows. Thequestion that must be answered during any prolonged movement up or down must bewhether everything is acting in concert. If, for example, the market averages are makingever-higher highs, is the AV keeping pace or does it seem to be tiring? One mustremember, again, that the differential will not track the price plot like a cheap detectiveevery 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 apullback or correction which is accompanied by a divergence in the differential is worthattending 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 themarket flew so near the sun that the wax in its wings began to melt and it plummeted toearth. Regarding only the AVDVd, '99 was not a particularly volatile year, at least untilNovember. There were a few minor divergences between the AVDVd and price, but theyhad more to do with lack of confirmation than serious divergence. Any doubts as to whatto do could be eased by the use of TLs and MAs, the opposite of what was demonstratedabove 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. Buteven 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 themost hopeful that the Nasdaq had in fact struck an iceberg and was rapidly taking onwater.


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