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Paul Allen has worked in the securities industry since 1998. Prior to his engagement with www.WallStreetCourier.com in 2009, he has been working for several top tier investment banks. Right now, Allen's position is Head of Quantitative/Technical Market Analysis. WallStreetCourier.com is an... More
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  • Myth Or Truth: Is The Golden Cross A Shiny Investment Approach? - An Empirical Investigation

    You probably have read a lot about the "Golden Cross" on different financial media and maybe you even thought of following such an investment strategy. The "Golden Cross" is a technical pattern which occurs when the 50 day moving average of a specific underlying security crosses above its respective 200 day moving average.

    The claim is that this signal quantifies the improvement in the trend of the underlying security and will lead to a significant uptrend. Since a moving average is an indicator that measures the average movement of an asset price over time, it is a confirmation of upward momentum when a short-term moving average crosses above a longer-term moving average and vise versa.

    Conversely, when the 50 day moving average crosses below the 200 day moving average, it is known as the "Death Cross", and is considered as an exit point. This technical pattern assumedly signals a significant downturn.

    In the literature (Joseph Granville, 1960) it is sometimes argued that a "Golden Cross" should also have a rising 50 as well as a rising 200 day moving average. For our analysis we will focus only on the "simple" moving average crossover since this version is more widespread among the investing community.

    In general there are two common ways to trade such a technical pattern:

    • The first approach (Long/Cash) is to trade only the bullish signals ("Golden Cross"), since not every investor is able to enter a short-position in the specific underlying of interest, while during a so-called "Death Cross", investors just take no investments (CASH) at all.
    • The second approach (Long/Short) is to trade the bullish- as well as the bearish signals, in taking a specific long as well as short position within the specific market.

    Methodology:

    For our analysis we are using the S&P 500 (IVV) as underlying market.

    • All used data is split and dividend adjusted. In addition, we have taken 2 days slippage into account, but we have excluded any taxes and trading expenses.
    • The analyzing period was from 10/18/1950 until 04/30/2012
    • In the Long/Cash version, no investment is being made during that time a "Death Cross" is predominant.
    • Both, the Long/Cash as well as the Long/Short strategy will be compared with a simple "Buy & Hold" for the S&P 500.

    Results

    Trade Analysis:

    From 10/18/1950 until 04/30/2012 the Long/Cash strategy generated 63 trades. Assuming zero transaction costs, this technical pattern would have been profitable with a mean and median profit per trade of 17% and 12.9% respectively. In total, 78.1 percent of all trades would have generated a positive return. The best trade would have produced a profit of 124% while the worst trade was down almost 10%. If we would treat the best trade as an outlier and remove that observation from the sample, the mean and median profit per trade would have been still above 10%.

    The results for the Long/Short strategy for the same time period are not as promising compared to the Long/Cash strategy. In total, this strategy generated 129 trades, as investors have additionally entered a short-position, if a Death Cross signal appears.

    Again, assuming zero transaction costs, this strategy would have been profitable with a mean and median profit per trade of 9.24% and 0.40% percent respectively. All in all, trading the Death Cross as well, this would have lowered the mean and median profit compared to the Long/Cash strategy, by 7.76% and 12.5%, respectively. In total, 55.4 percent of all trades would have generated a positive return.

    Trade Statistic
    Table 1: Trade Overview

    Performance Analysis:

    Table 2 summarizes the results for both Long/Cash and Long/Short. It also displays the relevant values for the naive buy-and-hold strategy for easy comparison.

    The results of back-testing the Long/Cash- and Long/Short strategy illustrate that on a day-by-day basis, those strategies slightly outperformed a naive buy-and-hold-portfolio but we have taken zero transaction costs into account.

    The Long/Cash portfolio has the lowest volatility, mainly due to the cash investment. Nevertheless this portfolio has the second highest annualized return and due to its low volatility it has therefore the best Sharpe ratio among all three portfolios.

    The main reason, why the Long/Short portfolio has outperformed the naive buy & hold- as well as the Long/Cash portfolio in terms of annualized returns, is the fact that this strategy has performed very well during the past long lasting bear markets (Table 5).

    Performance/Risk Ratios
    Table 2: Performance Analysis

    Calendar Returns Analysis:

    In total, only in 34.9 percent of all observations regarding the yearly results, the Long/Cash as well as the Long/Short version outperformed a Buy & Hold strategy.

    If we have a closer look on the dispersion of the yearly results (Table 6), we can see that the Long/Short Strategy gained a whopping 69.80 percent on a yearly basis, in 2008, compared to only 45% for a classical Buy & Hold Strategy in the year 1954.

    In terms of maximum yearly loss, both the Long/Cash as well as the Long/Short Strategy are clearly outperforming a typical Buy & Hold portfolio by at least 15%.

    Calendar Returns of the S&P 500 since November 1950 in detail:

    (click to enlarge)Calendar Returns S&P 500

    Table 3: Calendar Returns of the S&P 500

    Calendar Returns of the Long/Cash Strategy since November 1950 in detail:

    Calendar Returns Long/Cash
    Table 4: Calendar Returns of the Long/Cash strategy

    Calendar Returns of the Long/Short Strategy since November 1950 in detail:

    Calendar Returns Long/Short Strategy

    Table 5: Calendar Returns of the Long/Short strategy

    Dispersion of Yearly Results since November 1950 in detail:

    Dispersion of Yearly Results
    Table 6: Dispersion of Calendar Year Results

    Drawdown Analysis

    If we have a closer look at the historical five largest drawdowns, we can see that the main benefit of the Long/Cash- as well as the Long/Short strategy is their downside protection.

    Table 8 and Table 9 show how those two strategies would have significantly reduced the maximum drawdowns compared to a simple buy & hold portfolio (Table 7).

    The maximum draw down of the Long/Cash portfolio was only -33.2 percent compared to the naive portfolio which has lost -56.8 percent during the financial crisis. Even the more risky Long/Short strategy has a lower maximum drawdown than the buy & hold portfolio. Nevertheless, the recovery period is the longest when investors follow the Long/Short strategy. The Long/Cash strategy has on average the shortest recovery period, if we have a look at the five largest drawdowns.

    Largest Drawdown of the S&P 500 since November 1950 in detail:

    (click to enlarge)Largest Drawdowns S&P 500

    Table 7: Largest Drawdowns S&P 500

    Largest Drawdown of the Long/Cash strategy since November 1950 in detail:

    (click to enlarge)Largest Drawdowns Long/Cash

    Table 8: Largest Drawdowns Long/Cash strategy

    Largest Drawdown of the Long/Cash strategy since November 1950 in detail:

    (click to enlarge)Largest Drawdowns Long/Short

    Table 9: Largest Drawdowns Long/Short strategy

    Conclusions

    The testing results show that both, the Long/Cash and the Long/Short strategy have been very reliable since 1950. In the past, 78.1% and 55.4% of the trades for the Long/Cash and the Long/Short strategy respectively, have been winners.

    Exiting on a Death Cross would have kept investors out of most ugly bear market declines in the past. So if you believe that you are in an environment where lengthy declines of more than 30% are going to be the order of the day, following the Long/Short- or Long/Cash strategy instead of a Buy & Hold approach, can be useful.

    Upon a Death Cross signal the market shows general weakness to perform on the upside. This weakness can be difficult to short, if the there are no long-lasting periods of weaknesses. Moving into cash or selling short during this time may prevent you from experiencing significant drawdowns compared to a simple buy & hold strategy.

    However, as this method confirms an existing trend rather than predicting one, there is a chance that investors face a late-in and late-out problematic. Therefore in only 34.9 percent of all observations, those two strategies have outperformed a buy & hold portfolio in the long-run.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Tags: IVV, SPY
    Jun 05 2:35 PM | Link | Comment!
  • The Most Hated Stocks On Wall Street!

    Many investors are using the short interest ratio as a tool to determine the sentiment of a stock or the market. The short interest is the number of shares currently borrowed by short sellers for sale, but not yet returned to the owner (lender).

    Every short seller anticipates a declining stock market. A profit is made if the stock is bought back at a lower price than when it was sold short. When a large amount of short selling activity is occurring, market participants obviously expect prices to head lower. Short sellers are potential buyers sooner or later and represent a lot of buying power when they have to scramble for cover in a sudden market turn.

    The reasoning behind this is that the short positions must eventually be covered, which means that there will be more purchasers of the stock who in turn drive the price up. If a stock's price begins to rise significantly, investors who have short sold the stock will quickly begin to close out their positions (by purchasing shares off the open market), creating buying pressure for the stock and driving the price up even more.

    If a previously lagging stock turns very bullish, the buying action of short sellers can result in extra upward momentum and increased losses for short sellers who are slow to close out their positions. However, while a high short interest ratio can lead to high gains in the short-term perspective, this ratio does not provide any information about a sustainable appreciation in the underlying stock price!

    Listed below are ten companies that have the highest short interest ratio according to the latest bi-monthly short interest data released by AMEX, NASDAQ and NYSE.

    (click to enlarge)Most Hated Stocks On Wall Street

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Jun 04 2:00 PM | Link | Comment!
  • Back Testing The 200 Day Moving Average On All Stocks Within The Dow Jones Industrial Average

    In our blog, we will analyze different kind of technical market indicators on a regular basis.

    The 200 Day Moving Average is a very simple and well known technical market indicator. It helps to determine the overall health of a stock since a stock that is trading above its 200 Day Moving Average is being considerate to be in a long term uptrend and the other way round.

    In this issue, we would like to show some basic back testing for the 200 day simple moving average, which we have down for all three major U.S indices (S&P 500, Nasdaq and the Dow Jones Industrial Average) as well as for all stocks within the Dow Jones Industrial Average on a daily basis.

    All used data is split and dividend adjusted. In addition, we have taken 1 day slippage into account but we have excluded taxes and trading expenses. The analyzing period was from April 2002 until May 2012.

    The result of this back test shows you the cumulative returns of each underlying for a buy and hold strategy as well as the cumulative return of the specific underlying if its price was trading above and below its 200 day moving average. In addition, the table below shows the amount of total trades (long and short) which would have occurred by following the 200 day simple moving averages investment strategy as well as the maximum drawdown for each scenario.

    In total, only 36.4 percent of all observations, a long-/short strategy would have had outperformed a buy and hold strategy while the maximum drawdown was lower in 81.8 percent of all cases, if the price of the specific underlying was trading above its 200 day simple moving average.

    On average, an investor would have made 90 trades during 2002 and 2012 by following the 200 day simple moving average strategy.

    (click to enlarge)Back Testing The 200 Day SMA On All Stocks Within The Dow

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Tags: DIA, SPY, MMM, AA, AXP, T, BAC, BA, CAT, CVX, CSCO, KO, DD, XOM, GE, HPQ, HD, INTC, IBM, JNJ, JPM, MDLZ, MCD, MRK, MSFT, PFE, PG, TRV, UTX, VZ, WMT, DIS
    May 13 4:21 PM | Link | 2 Comments
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