How to Market Time like Paul Tudor Jones

How to Market Time like Paul Tudor Jones

July 24, 2018 0 By Jeremy




How to Market Time like Paul Tudor Jones

This post can probably be written entirely based off of Tony Robbin’s interview with legendary hedge fund dude Paul Tudor Jones in the book, Money: Master the Money Game. Here is an excerpt from that book that sums up Paul Tudor Jones’ market timing approach (with some editing used to pull together the thought into one paragraph):

I’m going to save you from going to business school. Here, you’re getting a $100,000 class, and I’m going to give it to you in two thoughts, okay? You don’t need to go to business school; you’ve only got to remember two things. The first is, you always want to be with whatever the predominate trend is…My metric for everything I look at is the 200-day moving average of closing prices. I’ve seen too many things go to zero, stocks and commodities. The whole trick in investing is: “How do I keep from losing everything?” If you use the 200-day moving average rule, then you get out. You play defense, and you get out.

To summarize, good investors trade with the predominant trend of the market.  Trading against the trend is difficult, and can easily lead to portfolio losses.

If you  want to market time like Paul Tudor Jones describes above, then all you need is a chart of the S&P500 (i.e. SPY) and the 200 day moving average trend line.  Here are the rules-based steps in order to trade with the trend:

  • If the market is trading above the 200 day moving average, you are free to buy assets and hold on to them.
  • If the market drops below the 200 day moving average, you sell your holdings and wait the downtrend out.

Keep in mind, in this definition of market timing you are not trying to predict which way the market is going to go. Instead, you determine the trend and invest with that trend.

Buy and hold when the market is going up (trading above the 200 day moving average).

Get defensive when the market is heading down.

Monthly or Daily Charts for Market Timing?

In the above quote about how to market time like Paul Tudor Jones, he referred to the 200 day moving average.  In that case, the moving average would be drawn on a daily chart to reflect what the stock price has done over the past 200 days.

However, some investors use the 10-month moving average.  In this case, the 10-month moving average is drawn on a monthly chart and reflects the trend over a 10-month period.

Which one should you choose?

Long-term it doesn’t really matter.  Meb Faber describes it like this, “It doesn’t matter what precise indicator you use (i.e., 50 day SMA, 10 month SMA, 200 day EMA etc), they generally perform similarly over time and across markets. Of course, in the short term there will be very large variation (example Oct 1987), but on average they are similar.”

The one thing to consider with the 200-day moving average versus the 10-month moving average is because the 200-day MA is drawn daily, it is more prone to whipsaws.  When a stock prices gets close to the 200-day, it can move above and below it each day, depending on what the market is doing.

On a 10-month chart, those whipsaws are not as prevalent since it trades based on the monthly price as opposed to the daily price.

What Market Timing is NOT!

The most common mistake that investors make with marketing timing is thinking that it will help your investment return.  It may actually mean you earn a lower return.  The benefit is that by market timing you are reducing risk by managing drawdowns and volatility. The result is a less volatile portfolio with a better risk-reward balance.

Don’t make the mistake of thinking that market timing will help your returns.  It may over the long term, but that is because you are protecting your capital and limiting drawdowns.

Chart Examples of Market Timing

200-Day Moving Average

So what do charts look like if you want to learn how to market time like Paul Tudor Jones?  Here is an example chart of SPY trading above its 200-day moving average.

How to market time like Paul Tudor Jones - SPY

Here is an example of an ETF trading below its 200-day moving average.  In this case VSS would not be a good investment based on the trend:

How to market time like Paul Tudor Jones - VSS

10-Month Moving Average

Switching to a 10-month chart, here is a SPY chart where it is trading above the 10-month moving average, which based on market timing principles would mean you could hold on to SPY:

How to market time like Paul Tudor Jones - SPY 10-Month

Here is an example of VSS, but based on the 10-month moving average chart.  Again, in this example the trend is negative and holding VSS would not be advisable if investing based on market timing principles.

How to market time like Paul Tudor Jones - VSS 10-Month

Is Market Timing Better than Buy and Hold?

People who dismiss market timing outright usually say that a simple buy and hold portfolio performs just as well or better than a portfolio that uses market timing. They are not wrong. A portfolio that uses a market timing system like this one does not see a huge increase in percentage gains compared to the returns of the general market.

However, as explained above, what it does provide is a way to limit the drawdown (or maximum loss) your portfolio experiences.

The issue becomes behavioral. It is proven that investors have a real nasty habit of selling at exactly the wrong time; when things are at their worst. When the shit is hitting the fan and the market is at its most pessimistic and prices have dropped huge, people panic and sell everything.

If we as humans are prone to this behavior, a better strategy is to put in place a process – rules – that protects you from these stupid mistakes and helps you take action when it is required.

For example, sell when the market drops below the 200 day moving average before a real massive sell-off happens. Sure you might miss out on some of the future upside, but at least you have not thrown out the baby with the bathwater.

At the end of the day, research has shown that portfolio performance is better when a market timing tools is used, as opposed to buy and hold. A great piece of research on this topic can be found in Meb Faber’s “A Quantitative Approach to Tactical Asset Allocation

Here is a table that demonstrate the power of the system. Notice that performance is better, but more importantly the MaxDD (maximum drawdown) is a lot lower. With our human tendency to avoid loss, which often means selling at exactly the wrong time, this simple market timing tool can help you manage that risk.

Market Timing ResultsIn this graph, pay attention those flat periods on the red line – that is the period of time the portfolios went to cash and protected investors from the larger drawdowns shown on the blue line. They are small periods of time in the scheme of things, but if you look closely you will see them (ex. ~1926, ~1946, 2008).

SPY Market Returns with Market Timing

Want More Research?

If that is not enough to convince you that my use of a market timing system is a good idea, then that is good. You are thinking for yourself (although you are going against the wisdom of Paul Tudor Jones and Meb Faber)!

If you want to check out more research on this topic then here are few resources for you to check out:

Alpha Architect

How To Time The Market Like Warren Buffet, Part 2, Part 3

Why Market Timing Is So Hard

Market Timing is Back in the Hunt for Investors

Bad Timing Costs Investors 2.5% a Year – highlights that people do the wrong things at the wrong times

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