Over the past few weeks, I’ve been mixing up my adventurous investing ideas with a rather more mundane subject – how to build a sensible portfolio using research-based analysis.

This week, I’m concentrating on perhaps the most crucial question for any investor: should you buy and hold over the long term or time your market entry (and exit) using some form of signal? Essentially, is timing the market worth the bother?

The academic evidence suggests not. Perhaps the most quoted study on this comes from US outfit, The Schwab Center for Investment Research, which has put some hard numbers on the practice of trying to buy when the markets are cheap and sell when they are expensive.

It looked at three buy and hold investors, who each received $2,000 annually for 20 years to invest in the markets – a grand total of $40,000. Two decades later here are the results....

● The Perfect Timer – $387,120. Strategy? The money’s put into the market at the monthly low point every year

● Treasury Bill (government gilt) Investor – $76,558. Strategy? Terrified of shares, the investor only puts his money into Treasury Bills.

● Autopilot Investing – $362,185. Strategy? This investor automatically invests the money on the day received and then leaves it alone.

Perhaps the last word on cynicism towards market timing should be left to Warren Buffett’s hero Benjamin Graham. In his classic text The Intelligent Investor, Graham declared: “We are sure that if [the investor] places his emphasis on timing, in the sense of forecasting, he will end up as a speculator and with a speculator’s financial results.”

The problem is that buy and hold investors – who buy through thick and thin and then sit back and enjoy the long-term fruits of risky shares – struggle to defend themselves against two charges. The first is that markets have become more volatile in recent decades and that while shares are more rewarding over the very long term, that might be a very long time indeed.

The most vocal critic is John Maudlin, the US analyst, who points out that investing can be dangerous, even for those with patience. He looked at 88 20-year periods and discovered that, although most generated positive returns, half produced compounded returns of less than 4 per cent, while less than 10 per cent generated gains of more than 10 per cent. Plenty of these 20-year periods generated negative long-term annualised returns.

The other key objection to the buy and hold argument is that other timing systems can provide better returns.

Professors Hashem Pesaran and Allan Timmermann, for instance, looked at simple systems to time the market. Using data from 1970 to 1993, their work suggested that, without the benefit of hindsight, an investor could have correctly predicted the direction of the UK stock market roughly 60 per cent of the time, on a monthly basis. They said that when exploited in a market timing strategy, investors could have more than doubled their returns per unit of risk, even after transaction costs. The academics believed that using publicly available information, such as interest rates, money growth, oil prices and industrial production, small degrees of predictability still remain.

I’ve already mentioned in this column one idea from Mebane Faber, detailed in a paper called “A Quantitative Approach to Tactical Asset Allocation”. His solution is the 200-day moving average. The rule is to hold when the asset price or market shows a monthly price above the 200-day moving average and sell when it moves below, which indicates that the trend is moving against you. Faber’s system underperforms the index marginally in roughly 40 per cent of the years since 1900. But it cuts down on risk, loss and volatility.

Matthew Vincent, editor of FT Money, has played around with an even simpler idea – using the 20-day moving average on the FTSE 100 as a buy and sell signal. This idea generates more trading positions in and out of the market but it still helps to cut the risk of big losses.

Many investors like a signals-based strategy using valuation measures, in particular the cyclically adjusted price to earnings ratio, or Cape. The Cape measure smooths out earnings over a 10-year period for the aggregate market and comes back with a simple p/e ratio for the S&P 500 index, which is currently around 18. My preference is to work out a long-term average for Cape – currently around 16.5 – and the standard deviation either side (about 6.5). I start to sell my positions when this measure is one standard deviation above the average and completely exit equities when it’s two standard deviations above. Conversely, when it’s more than one standard deviation below the average, I aggressively buy.

The crucial point is not to use just one measure. I look at an array of indicators including Cape and the 200-day moving average plus two others. I like to look at volatility via the VIX – I’m cautious when the VIX is above its long-term average – and I also check a measure that examines flows of assets into and out of the market (currently flashing red).