We look at simple moving averages and moving average crossovers.
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Today we look at the book; Five Moving Average Signals That Beat Buy And Hold.
We take a ride through the research and back tested results, using the 20, 50, 100, 200 and 250-day moving averages, including crossover combinations.
The book demonstrates that by using a systematic approach, you will know when to be in the market, or when to get out the market, and cash in before a market downturn.
The question is posed, can you beat buy and hold?
The efficient market hypothesis would have you believe that all known data is reflected in current asset prices, and it is therefore impossible to beat the market.
Conversely, traders like myself and other gurus covered on this channel know the market can be beaten, and the moving average indicator is just one of the tools we can use to do it.
The book uses the S and P 500 (or SPY ETF) as the benchmark when comparing the moving averages.
The 1st to be covered is the 200-day moving average, described as the most popular and used by the likes of market wizard Paul Tudor Jones.
In this study, we use daily stock prices and the crossing of the 200-day moving average to determine our position. The back tested results are produced from the year 2000 through to 2016 and captures bull, bear, and sideways moving markets.
A signal should only be acted upon once per month, at the end of each month. Therefore, a maximum of twelve trades could be generated per year.
To enter a long position, we need to see price cross above the 200-day moving average, which we see here, although we need to wait until the end of the month to confirm and place a trade.
The end of month approaches, and we confirm our long position and enter a trade.
We then sit and wait out the whole month to determine our next trade decision. Notice how price could drop below the 200-day moving average but remain above it at the end of the month. In this situation we would hold onto our long position and therefore leave the trade alone.
If the price continued and closed below the 200-day moving average at the end of the next month, we would sell our position and remain in cash, whilst waiting for the end of the next month to see if price crossed and remained above the 200-day moving average, at which point we would re-enter a long position.
The back tested results of this simple moving average, index tracking strategy, against a buy and hold strategy are remarkable.
If we bought the S and P 500 index in 2000 and simply held it until 2016, we would have seen a total gain of 125.2%, accompanied by a maximum drawdown 55.2%.
If, however we followed the 200-day moving average strategy over the same period, we would have seen a return of 317.7%, with a maximum drawdown of 17.3%. In effect tripling the returns of buy and hold whilst reducing the drawdowns by more than two-thirds.
In essence, a rather simple but effective trend following strategy.
Next, we have the 250-day moving average, using the same S and P 500 index as the benchmark.
The signal to buy for this strategy is when price crosses and closes above the 250-day average, and unlike the previous strategy we do not wait for the end of the month, we wait for the close of the day instead.
Once the trade is entered, we watch the price either continue its trajectory or cross back below the moving average line. If at the end of any given day price closes below the line, we close our position.