2014 Planning: Two Sell Signals to Watch For

In looking ahead to the New Year, a great many investors will be trying to avoid the big mistake of 2013: missing out on the gains available in the U.S. stock market. You see, even with the recent "sloppy period," the S&P 500 SPYis up 24.9 percent year-to-date, the Russell 2000 IWM sports a gain of 32.1 percent, and the NASDAQ Composite QQQ has returned 33.3 percent in 2013. Not bad. Not bad at all.

However as we have discussed, investors of all shapes and sizes (including a great many with degrees from Ivy League business schools) did not capture even half of the gains seen in the stock market this year.

The culprit for the underperformance in 2013 was simple. If you hesitated, played it safe, worried about the macro picture, or decided to hold a broadly diversified portfolio, you underperformed. Because, in short, the U.S. stock market was the only place to be.

This is not to say that investors should allocate all of their assets to the stock market. No, the point is that it was oh-so easy to miss out of on the big gains in stocks. And frankly, a diversified portfolio is a great idea the vast majority of the time. Just not in 2013.

To be clear, diversification is NOT the crime. No, the real problem for investors was the underperformance with the assets that were supposed to be invested in U.S. stocks.

Whether it was the sequester, Cyprus, the budget talks, fear of the overall economy, or the overbought condition, there always seemed to be a reason to be afraid of what might happen in the stock market. And since the market didn't offer a single pullback of even 5 percent, there weren't many opportunities to get in.

You Need a Plan For the Stock Market

Obviously, no one knows what 2014 will bring. Some respected analysts say a bear market is coming. Others say now is the time to buy. So perhaps the first thing investors need to do in order to prepare for the New Year is to stop listening to every self-proclaimed expert's opinion and formulate a plan.

For the assets you have allocated to the stock market, develop a plan for when to buy and when to sell. And no, sticking a moist finger into the wind, flipping a coin, or looking at the phases of the moon are not strong alternatives.

In short, you will probably want to have a plan that includes something beyond guessing. Perhaps something that has proved successful in the past. Something that has a long history. Something you can measure. Something that you could use if you only have a few minutes a week to work at the markets. And something that puts the odds of success in your favor.

So, as promised, we will spend the rest of our time today reviewing a couple of sell strategies. Because, you just might need both in the coming year. And then, before the weekend, we will showcase a very strong buy signal to watch for.

But first there is an important caveat to consider. The indicators being presented this week are long-term in nature. These "triggers" don't happen very often and they will NOT get you into the stock market at the bottom or out at the top. However, when used religiously, they WILL keep you on the right side of the market's really important moves. (Which is where the truly big money is made and lost.)

A Sell Signal to Watch For

One of the absolute best ways to stay on the right side of the big bull and bear markets involves identifying the technical health of the market's industry groups. The idea is to go long the S&P 500 when more than 56.5 percent of the industry groups are "healthy" (above their respective 200-day moving averages) and go short when the number of health industry groups falls below 45.5.

Since 1980, there have been twelve buy signals and twelve sell signals issued by this system. History shows that 88 percent of these trades have been profitable. And by using a long/short approach, the system would have produced annualized gains of 18.2 percent per year, which is more than double the buy-and-hope approach return of 8.6 percent.

Perhaps what is most important is the fact that the sell signals have been quite timely. For example, this system got you out of the market before the big declines seen in 1981-82, 1987, 2000, 2002, and 2008.

An Easier Way

While this signal is obviously effective, it is difficult for the average investor to calculate. Sure, you could read this column each day - because when this signal occurs, we will be sure to issue a "public service announcement" and let everyone know. However, there is a simpler approach and one that might be equally effective in the coming year.

Take a look at the chart below. The black line is the S&P 500 monthly since 1995. The maroon line is a 13-month exponential moving average. This type of chart should be easy to produce for free on the internet.

This is a VERY simple trend-following approach. As you can see on the chart, if one were to stay long the market when the S&P is above the maroon line and in cash or short when the market is below the maroon line, you'd be on the right side of the market the vast majority of the time.

To be sure, there are "issues" with such a strategy. While those quick dips below and then right back above the maroon line don't look like much on a chart covering nearly twenty years, they can be costly in a given year. And for this reason, playing this game alone is probably not a good idea.

However, if you want a simple and easy-to-follow way to keep you out of harm's way if the bears show up again in 2014, this indicator could do a pretty good job. And if the bulls manage to extend their run into the first part of the year, we might even shorten up the moving average to nine or ten months.

But for now it's time to focus on what Ben Bernanke has to say, one last time.

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