The Stories of Moving Averages’ Demise Are Greatly Exaggerated (Again)
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.
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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:
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.
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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.
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Filed under: Trading Strategies, Trend-Following | 14 Comments