Many have said the most important purpose for investing is to make money. In order to make money we face two key decisions, when to buy and when to sell. Simply put, we must buy when prices are low and sell when prices are higher than the buy price.

The difficulty is in the implementation, our emotions work against us, when markets are rising there’s a jubilation that makes it very easy to join in and buy when prices are high and moving higher. When markets are low, it can seem like there is no bottom, the market will never bounce back, which makes it easy to follow the herd and sell low. Ideally, what we need is a system that will reduce the emotion of investing by automatically telling you when to buy, sell, or do nothing. In the late 1970’s Robert Lichello published a book titled “How to Make $1,000,000 in the Stock Market – Automatically” which presents a stock market timing system that claims to do exactly that. In this article we will briefly explain this system then back-test it to see if there is any credence to these claims.

Robert Lichello named his market timing system Automatic Investment Management or AIM. AIM is an algorithm that provides a logical system for managing your investments. It can be used with a stock or mutual fund portfolio. This system will instruct you when and how much to buy or sell.

To calculate AIM’s buy and sell quantities you need to know two things: how much money you have invested in the portfolio and the current value of your portfolio. To illustrate, let’s run through a couple examples.

Example of a buy order:

Portfolio Control (Amount of initial investment) = 1000 shares @ $10 per share = $10,000

One month later the stock price falls to $8, Portfolio Value = $8000

Add 10% to the current portfolio value = $8800.

Subtract 8800 from 10,000

Which equals = $1,200

Note, a positive value indicates a buy signal.

Because the value of your investment has decreased AIM has signaled you to buy 150 shares, the equivalent of $1200.

One of the interesting features of AIM is each time that you buy more shares your portfolio control increases by half the purchase value. In this case, the portfolio control would increase to $10,600. This is a built in risk regulator that will stop you from exhausting your cash reserves when the market is going down or building too much of a cash reserve when the market is going higher.

Example of a sell order:

Portfolio Control (Amount of initial investment) = 1000 shares @ $10 per share = $10,000

One month later the stock price rises to $13, Portfolio Value = $13,000

Subtract 10% from the current portfolio value = $11,700

Subtract $11,700 from $10,000

Which equals = -$1,700

Note, the negative value indicates a sell signal.

Because the value of your investment has increased AIM is telling you to sell 130 shares, the equivalent of $1700.

In both cases AIM has you making the correct decision, buying when your portfolio value goes lower and selling when it goes higher. If AIM is strictly followed it can be used to take much of the emotion out of investing.

So, does AIM work in the real world? To answer this question we will use historic stock prices and run the AIM algorithm through its paces. We will use a 10-year price history of one of the most active exchange traded funds (ETF), The S & P Depository Receipts, stock symbol SPY. SPY is an ETF that tracks the Standard & Poors index of 500 stocks.

From January 2000 to now (10/23/2009) the SPY price history has ranged from $68.11 to $156.48. During this period there has been two downturns in the stock market, one 5-year period of increasing prices and of course the current price increases since March of 2009. So we can test AIM through a couple buying phases, at least one selling phase, and get a read on the current market.

Now, let’s look at the results of the back-testing which is summarized on the time series graph titled AIM in Action and shown below. All buy and sell transactions are noted with yellow text boxes that show the month/year, quantity bought or sold and closing price at the end of that month. Additionally, buy transactions are denoted with red markers, sell transactions denoted with green markers.

The first thing we notice is that the initial purchase of 68 shares on 1/3/2000 is very near where the market peaked in August of 2000. Then as the market fell for the next two years AIM had us accumulating a total of 71 shares over three distinct buy signals in September 2001, and July and September of 2002.

After the market bottomed in 2002, we experience a 5-year period of rising prices. During this period, AIM would have us selling a total of 40 shares at two distinct selling opportunities in January 2006 and May 2007.

From the market peak in October 2007 there is nearly a straight-line tumble until February 2009. During that freefall, AIM has us accumulating a total of 110 shares over four distinct buy signals in October and November 2008, January and February 2009.

Finally, as the market started to pick up in March of 2009 it has risen to the point that as of 10/23/2009 AIM is signaling us to sell 22 shares.

In spite of the initial purchase being close to a market top, the overall portfolio performance is not bad. As of 10/23/09 the hypothetical portfolio consists of 209 shares of stock and $2,805 in cash reserves for a total of $25,393 which equates to a gain of $5,393. Employing a buy and hold strategy would have resulted in a total of $19,493 which equates to a loss of $507.

AIM appears to do a better job of accumulating shares as the market goes down then selling as the market climbs. Intuitively, it just seems like there should have been more than two sell opportunities during that 5-year period from September 2002 to October 2007. During the two market downturns AIM caught both bottoms with buy signals, on the up side AIM missed selling at the 10/2007 peak leaving about $158 of profit on the table.

Overall the AIM system appears to do a good job of identifying key buy/sell points. If you are disciplined enough to act only when AIM tells you to buy/sell much of the emotion of investing can be eliminated.

If you are interested in obtaining the source data for this analysis in spreadsheet form, send an email to dougburkeaz@aol.com with the words “AIM Back-Test” in the subject line. We will also perform a sensitivity analysis on AIM and publish the results so keep an eye out for future hubpages.

It is always necessary to make some basic assumptions when doing an empirical analysis, here is the list for this analysis:

1.       Initial amount to invest in the stock is $10,000

2.       Cash reserve of $10,000 for future purchases

3.       AIM decisions are based on the closing price of the stock on the last trading day of each month

4.       Buy or sell price is the open price of the stock on the 1^st trading day of each month

5.       Minimum buy or sell lot size is 20 shares

6.       Stock trading commission is $10.95 per trade

7.       Rate of return on Cash reserve is 2% APR