Seeking Alpha

2 Technical Market Timing Indicators Tested From 1872

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Includes: IVV, SPY, VOO
by: Fred Piard
Summary

Index moving average crossovers are proven tools to cut large drawdowns.

However, they give false signals and may also cut the return.

Here is how combining two of them might reduce the noise.

Technical indicators are factors calculated from price and volume data. Those used for market timing are mostly based on price. The most used ones are index trend indicators: price variation on a given look-back period (momentum) and moving average crossovers. One of the most extensive studies of the momentum anomaly across all asset classes has been done in Time Series Momentum (T. Moskowitz, Y.H. Ooi, and L.H. Pedersen, 2012). Forecasting Stock Returns in Good and Bad Times: The Role of Market States (D. Huang, F. Jiang, J. Tu, G. Zhou, 2017) went a step farther by suggesting that momentum could be interpreted more accurately after introducing the concept of market state. This article will stay at a basic level, references are given as additional sources for curious readers.

Simple moving averages are defined as the mean of closing prices on a defined trailing time interval using a defined time unit. For example, the 200-day simple moving average of the S&P 500 is the average of daily closing prices of the index for the last 200 trading days. The most famous signals are the bearish Death Cross (50-day simple moving average crossing below the 200-day simple moving average) and the bullish Golden Cross (the opposite). Another widely used signal is when an index crosses above or below its 10-month moving average (Where the Black Swans Hide & the 10 Best Days Myth, M.T. Faber, 2011).

I will show market timing test results based on monthly decisions. SPX will be by definition a monthly data series calculated as the average of S&P 500 daily closing prices during the month. On the 1st day of month “m”, we can make decisions using the value for month “m-1”, noted SPX(m-1). Each indicator gives a binary signal “bullish” (0) or “bearish” (1). Every indicator is tested by calculating the performance of an investment in the S&P 500 (VOO, or IVV, SPY) with a market timing strategy going gradually out of the market during the month of a bearish signal. Gradualness is simulated using the average of daily closing prices as monthly price. It means a trade “off” or “on” is smoothed along the month, as if 1/21 of the trade was executed every day on market closing for an average month of 21 trading days. The first advantage is that it is easy to get a free and reliable price data series based on this rationale on a very long period (Robert Shiller’s online data). The second advantage of using smoothed monthly prices is a lower sensitivity to short-term moves. There is no risk to design a model unwillingly curve-fitted to a series of specific daily prices (the first trading days of every month). There is a third advantage: it is more realistic for investors who cannot make a big move on a single day because of capital size or compliance (especially fund managers).

The following tests simulate going to cash on a bearish signal. Obviously, this is rarely the best strategy. Opening or increasing hedging positions is usually a better way to manage riskier periods, incurring lower trading costs when the portfolio is in many positions or when holdings are not very liquid. It also keeps dividends coming when there are some.

Two indicators based on the large capitalization benchmark are tested below. The first one is defined as bearish when the stock index is below its 10-month simple moving average (hereafter named 10mma) and bullish otherwise. The second one is bearish when the 3-month simple moving average (3mma) is below the 12-month simple moving average (12mma) and bullish otherwise.

A combination is also tested: bearish when both bearish conditions are met and bullish otherwise.

In the tables below:

  • CAGR is the annualized return in percentage points.
  • Ddmax is the maximum drawdown depth also in percentage.
  • DLmax is the maximum duration in months.
  • MAR ratio is a risk-adjusted performance metric defined as MAR = CAGR / Ddmax.
  • The first column gives the starting year for each test, the end date is always 1/1/2019.
  • For all tables, benchmark data are repeated in italic to facilitate comparisons (S&P 500, buy and hold).

In the first series of tests below, the bearish signal is given by SPX(m-1) < 10mma.

Since

CAGR

MAR

Ddmax

DLmax

CAGR

MAR

Ddmax

DLmax

2000

3.22

0.06

50.82

80

5.17

0.36

14.42

38

1956

6.68

0.13

50.82

89

5.79

0.21

27.11

76

1913

5.46

0.06

84.76

299

5.91

0.11

53.65

184

1872

4.37

0.05

84.76

299

4.86

0.09

53.65

184

In the second series of tests, the bearish signal is given by 3mma < 10mma.

Since

CAGR

MAR

Ddmax

DLmax

CAGR

MAR

Ddmax

DLmax

2000

3.22

0.06

50.82

80

4.40

0.31

14.07

40

1956

6.68

0.13

50.82

89

5.40

0.20

26.84

72

1913

5.46

0.06

84.76

299

5.71

0.15

38.71

81

1872

4.37

0.05

84.76

299

4.83

0.12

38.71

141

In the first series of tests below, the bearish signal is given by SPX (m-1) < 10mma and 3mma < 10mma.

Since

CAGR

MAR

Ddmax

DLmax

CAGR

MAR

Ddmax

DLmax

2000

3.22

0.06

50.82

80

5.33

0.41

13.04

39

1956

6.68

0.13

50.82

89

6.10

0.22

28.30

72

1913

5.46

0.06

84.76

299

6.15

0.12

52.97

99

1872

4.37

0.05

84.76

299

5.05

0.10

52.97

166

Chart since 1993:

The three SPX indicators do a great job at improving the risk-adjusted performance measured in MAR and reducing drawdowns in depth and length on all studied intervals. They generally improve the absolute performance measured in CAGR, but result in lagging a bit the benchmark since 1956. The indicator combining two conditions to send a bearish signal is the best in CAGR on all intervals. The 3mma/10mma crossover alone is the best for Ddmax reduction and MAR improvement (by a short margin) for the longer periods.

Disclosure: I am/we are long SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Past performance, real or simulated, is not a guarantee of future returns.