Fuel Gauge: A Simple Way to Time the Market

If you are anything like me, then you get anxious waiting for the moment until the next paycheck arrives in the checking account. If you are even more like me, then you get even more excited afterwards because you now have money to go shopping!

Buy in Bulk

When it comes to purchasing shares of your favorite companies, you soon realize that even a full paycheck doesn’t take you very far. With commission fees at most brokerage houses ranging from $4.95 to $9.95 a transaction (excluding DRIP), it only makes sense to buy in large amounts each time to minimize the impact of the commission fees. By reducing your cost basis, you get to maximize your dividend yields.

The Waiting Game

Since it takes most people about two weeks to receive fresh capital from their day jobs, and oh, about 20 seconds to spend it all, you can easily see how this can present a problem. For all intents and purposes, we spend most of our time on the sidelines awaiting more funds to come in so we can go hunting again.

Now, in a bull market, this doesn’t really present a problem. If the market soars while we have no funds, it’s no big deal. We just continue monitoring as usual. If the market is still overvalued when reinforcements arrive, we just continue waiting patiently until a good entry point arrives.

However, when a major pullback, or correction is just around the corner following our most recent purchase, the next waiting period can be agonizing to endure! Case in point, I purchased shares of Abbott Laboratories (ABT) and McDonald’s (MCD) on November 7, the day after the election. Stocks sold off so much that day that it was hard for me to pass up on the good deals. But by going “all in” too soon, I ran out of funds early, well before the “real” big pullback event occurred, lasting from around November 12-15. So, in the short-term, I missed out on a really good buying opportunity.

Market Timing

In the long-run, market timing doesn’t really matter. The short-term jitters get swamped out by the “2 steps forward, 1 step back” forward momentum (provided you picked the right companies to invest in). Still, as bargain hunters, we always want to maximize our capital to get the best deal possible. The missed opportunity described above has taught me the importance of always having some cash handy in reserves. What I’m missing now, though, is an indicator to let me know when to make the big splash.

Short-Term Chaos
More Legible

Valuation Tools

There are many tools one can use to help decipher the overall market to help figure out when a good time to load up on stocks is. Some people like to track 200 day moving averages, paying close attention to when a stock dips below it. Others set up a relative strength index to determine when a particular stock reaches oversold territory. We can compare the current P/E ratio with historical data. Another easy observation to make is to see how far off the current share price is from its 52 week high and 52 week low.

Or we can just eyeball an index, like the S&P 500 and buy when it dips or double dips. A simple approach may be to just set an arbitrary number, like 1380, and buy in bulk whenever the index falls beneath the line.

Buy Below Yellow

Fuel Gauge

But wouldn’t it be nice if there was an even easier way to decode all of this information? When you are driving your car, do you really pay any attention to anything that is going on underneath the hood? As long as the vehicle moves you from Point A to Point B, and doesn’t make any funky noises in the process, you just go on assuming everything is a-ok. In fact, I would venture to guess that 99% of all drivers have no idea how an internal combustion engine works.

So, how do these people get by? Easy. They simply refill the gas tank when the indicator points to “Empty”, or the emergency light goes off. Can’t we have the same simplicity for our stock investments?

Actually, we do. CNN Money has this neat little fuel gauge they use to monitor the market. They call it the Fear & Greed Index. How does it work?

From the CNN Website:

We look at 7 indicators:

Stock Price Momentum: The S&P 500 (SPX) versus its 125-day moving average
Stock Price Strength: The number of stocks hitting 52-week highs and lows on the New York Stock Exchange
Stock Price Breadth: The volume of shares trading in stocks on the rise versus those declining.
Put and Call Options: The put/call ratio, which compares the trading volume of bullish call options relative to the trading volume of bearish put options
Junk Bond Demand: The spread between yields on investment grade bonds and junk bonds
Market Volatility: The VIX (VIX), which measures volatility
Safe Haven Demand: The difference in returns for stocks versus Treasuries

For each indicator, we look at how far they’ve veered from their average relative to how far they normally veer. We look at each on a scale from 0 – 100. The higher the reading, the greedier investors are being, and 50 is neutral.

So Simple!

Simple is Good

Ok, I’ll admit, I only recently discovered this fuel gauge, and have no idea how accurate it actually is. But I really like the simplistic nature of it all. Like the internal combustion engine that powers your car, it does all the calculations and grunt work behind the scenes. As a user, I simply just need to look at the indicator, which will let me know if I should be gassing up (Extreme Fear; 0-25), or continuing to cruise along.

Here is a graph of the Fear & Greed Index over time. As you can see, in 2012, the fuel gauge dipped below 20 (Extreme Fear) in June. In this case, it does coincide nicely with the best buying opportunity that’s presented itself so far this year. The gauge is currently sitting at 52, or neutral.

Buy Line

Conclusion

I’ll continue buying stocks and doing my own research and analysis. From time to time, though, I will track this fuel gauge and pay special attention to see when it does dip below 20 again. The stock market is inherently cyclical, and thus far, you can see that it does cross over into Extreme Fear territory at least once each year. If this fuel gauge is indeed accurate, we’ll be on the same page the next time it breaches below 20, and I’ll be backing up that monster truck!

 

What do you think? Clever tool? Or mainstream gimmick?

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Part 2: The Secret Recipe for Retiring Early (Using the Stock Market)FI FighterCompounding IncomeJC @ PassiveIncomePursuitLeigh Recent comment authors
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Executioner
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Interesting concept. Could be a nice supplement to an investing decision.

Leigh
Guest

“If you are anything like me, then you get anxious waiting for the moment until the next paycheck arrives in the checking account.”

That is so me! I sometimes wish I got paid more than once a month so that I could move money to savings more often, but I do like getting the large lump of money that monthly pay gives me. I sent a couple thousand to my mortgage this morning 😀 I’m so close to having paid off 10% of it! (That should hopefully happen next month.)

JC @ PassiveIncomePursuit
Guest

Keeping some cash around for the potential big drop is my biggest issue with investing. I would’ve picked up some PM earlier this month but I had no cash available so I couldn’t. This could be useful in conjunction with the usual research and analysis. Thanks for sharing.

Compounding Income
Guest

Wow that is really interesting. I’ve never heard of the fear and greed index, but it does make sense. It’s a way to quantify what I normally just sense. Half the time my spider senses fail me though, haha! I wonder how accurate it is?

I’m pretty sure August 2011 would register almost 0, that was the craziest volatility I’ve ever seen. Massive 500 point DOW swings every day for like a week. I literally thought the DOW had a decent chance to plummet to 6,000. It was scary as hell but I escaped with 2 amazing buys. We haven’t had a conviction test in quite a while….

Thank you for bringing this to my attention. I’m actually pretty good at keeping money on the sidelines, this might be useful. It’s at least worth a look!

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