The Stories of Moving Averages’ Demise are Greatly Exaggerated
This is a response to Blake LeBaron, a finance professor at Brandeis University, who speculates that since 1990 something has permanently changed in the financial markets that has made moving averages mostly ineffective (read more and more).
In this post I’ll to show that, in the case of the U.S. stock market, not only is LeBaron wrong, he’s standing diametrically opposed to the facts: moving average crossovers have been more effective over the last decade than at any point in the last 80+ years.
Recall the graph above from my post testing the most venerable of moving average crossover strategies, the Golden Cross.
In red I’ve assumed an investor went long the S&P 500 at today’s close when the 50-day simple moving average closed above the 200-day, otherwise to cash, from 1930. For comparison I’ve also included buy & hold in grey.
See end of post for assumptions about dividends, return on cash, and trade frictions.
Recall too that the benefit of long-term crossover strategies like this one has never been generating returns; it has been improving risk-adjusted returns and managing drawdowns. So any discussion about the effectiveness of crossover strategies has to focus on those two metrics.
In the graph above I’ve shown the rolling 10-year “volatility-adjusted return” of the Golden Cross (red) versus buy & hold (grey). By vol-adjusted return I mean annualized return divided by annualized volatility (like a Sharpe Ratio without the risk-free discount).
A higher number would indicate that the strategy performed better on a risk-adjusted basis. The graph shows that the Golden Cross has consistently either matched or outperformed buy & hold.
By how much?
In the following graph I’ve shown the difference between the two lines (i.e. subtracted the grey line from the red line). Positive numbers indicate that the Golden Cross outperformed buy & hold.
In terms of excess vol-adjusted returns, since at least 1930 the Golden Cross has never done a better job trouncing the market than it has in the last 10+ years.
The bear markets of 2000-02 and 2008-09 gave long-term MA strategies a unique opportunity to shine, and at least in the case of the U.S. stock market, the stories about the demise of these strategies have been greatly exaggerated.
For me and my money, I’m still a proponent of more active short-term strategies, but for now, long-term moving average crossovers still remain a significant improvement over straight buy & hold.
P.S. for brevity I didn’t show it, but the same conclusion holds when looking at drawdowns (the other benefit of long-term moving average strategies like this one).
Test assumptions: (a) I’ve calculated the moving averages using the S&P 500 cash index (which traders generally use), but calculated returns based on daily dividend-adjusted data (dividends interpolated from quarterly data), (b) results are frictionless (i.e. do not account for transaction costs/slippage) but could be closely reproduced in today’s market using mutual funds less part of an annual expense ratio, and (c) I’ve assumed a return on cash of half the nearest 13-week Treasury.
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Filed under: Trading Strategies, Trend-Following | 14 Comments