The Stories of Moving Averages’ Demise Are Greatly Exaggerated (Again)

24Feb13

Readers know I’m not one to preach trend-following (at least relative to other more active, more effective strategies), but I have to stand up and defend the honor of this granddaddy of quantitative strategies from some recent negative press, such as the latest from Mark Hulbert.

Hulbert makes his case that the 200-day moving average (the most commonly quoted trend-following indicator) has become a poor predictor of future stock market returns because it’s done a poor job generating return in recent decades.

Regardless of whether that’s true, it completely misses the point of what trend-following indicators are and have always been useful for: reducing drawdowns and volatility (NOT generating above average returns).

I did a long numbers-centric post on the subject a couple of years back that I would suggest interested readers digest. It was about 50/200-day crossovers (aka “the Golden Cross“), but the conclusion was the same.

Long-term moving averages have never been useful for generating above average returns timing the stock market for any length of time. But they have consistently done a good job at capturing most of the stock market’s returns, while reducing volatility and sidestepping the worst of its drawdowns.

That’s been as true for the last decade as at any point since my test began in 1930.

. . . . .

Pulling an example from Hulbert’s post, Hulbert states that since 1990, a trader would have only returned 3.8% annualized by trading the DJIA when it was above its 200-day moving average, versus 7.3% for buy & hold.

Below I’ve run my own test (trend-following in red, buy & hold in grey). Note that I’ve used the S&P 500 in place of the DJIA, and I’ve adjusted returns for dividends, but the point is the same:

20130224.01
[logarithmically-scaled, growth of $1]

Yes, trend-following has underperformed in terms of return, especially over the last couple of years, but that shouldn’t come as too big a surprise. Again, read my previous numbers-centric post. It’s par for the course.

More importantly, look at what it’s done to reduce loss/volatility: max drawdown was halved at -27% versus -55%, Sharpe Ratio increased by 20%, UPI increased by 30%, etc. That’s also par for the course.

. . . . .

I don’t use trend-following indicators in my own trading today, so I don’t have any skin in this game, but I recognize that the type of short-term strategies we’re trading are just too active for a lot of investors.

And for those folks I think trend-following, applied to the stock market as part of a diversified portfolio, is a huge improvement over buy & hold.

Happy Trading,
ms

. . . . .

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14 Responses to “The Stories of Moving Averages’ Demise Are Greatly Exaggerated (Again)”

  1. Hulbert’s post is mostly irrelevant. I don’t know of any indicators that can “beat” the market on a stand-alone basis (if there were one, well…). Serious technical analysis frameworks always mix several approaches and take great care of context (one indicator might work in a trending market but shuold be disregarded in a range market for example).

    • 2 MarketSci

      Hello Assylias – while the geek in me agrees with you, the realist in me says that it’s not feasible to ask the vast majority of active investors to have that level of market knowledge. And for those investors I think simple long-term strategies like trend-following are an improvement over straight buy & hold.

      So from the realist’s perspective, Hulbert’s post isn’t irrelevant. He commands more eyeballs than any other blogger who takes a quantitative approach to the market (as inaccurate as that quantitative approach may be), and what he says influences a lot of people. I think combating these inaccuracies has value.

      Thanks for the comment. — michael

  2. 3 Calvin Harris

    We’ve established that the returns are equal but lower drawdowns.

    What if we invested long only when the mkt was one or two std dev below the 200ma?

    That might get some increased returns to go with the vol.

    • 4 MarketSci

      Hello Calvin – there are an infinite number of trend-following variations out there. I don’t have an opinion on which is best because this isn’t how I trade, but all of the variations that I’ve seen follow more or less the same conclusion laid out in this post. michael

  3. 5 Mike

    Further, one can park money in short term treasuries when the market is below its 200dma to enhance returns.

    • 6 MarketSci

      Hello Mike – agreed. I believe reduced exposure to beta and/or the market is always a good thing assuming that performance doesn’t suffer. michael

  4. 7 Pierre

    Way not combine trend following (reduced volatility and drawdowns) with a SP500 leveraged ETF (to get 2 to 3 Times the yield ?

    • 8 MarketSci

      Hello Pierre – leaving aside the (major) issue with leveraged ETFs acting as a drag on returns, if I were going to take on this much beta, I would want to be chasing a more predictive strategy than simple trend-following. michael

  5. 9 Rick

    I looked at your 2010 post and it’s funny because the golden cross performance has turned negative since then as I recall from an article I have read in another blog: http://bit.ly/YuRcBO

    • 10 MarketSci

      Rick – I’m unclear what you’re point is. My post you refer to provides statistics showing how, since 1930, the Golden Cross has gone through multiple DECADES of under- and outperforming buy & hold, but that in aggregate, it’s reduced volatility and drawdown.

      You show me a post showing how the strategy has been shite for the last few years. How are those two things not perfectly in line? Additionally, the post you referred to assumed the trader shorted the market when the 50-day SMA was below the 200-day which I’ve been very clear has never been a consistently productive trade.

      Again, I have no skin in this game because I don’t use trend-following, but I want to make sure good information is out there and I’m confused as to what you’re point is. michael

  6. 11 Jim

    What happens if you go short when below the 200-day? Does it increase returns or just make a mess?


  1. 1 Monday links: a wobble in flight - Abnormal Returns | Abnormal Returns
  2. 2 Pseudo Random News and Comment | Mortality Sucks

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