The Moving Average Method: Is It Any Good?

by: Bill Buchanan

With the current downtrend, the market timing folks are beginning to come out of the walls to talk about how they sold everything, or went short, when the S&P 500 crossed its x day simple moving average. I'm here to dispute that as a viable long term strategy. If you followed this advice, you may be feeling good short term, but the question is, now that you're all cash or short, when do you go long again?

Since I already tested this theory on the major indexes, I decided to try against various moving averages and with the individual components of the Dow 30 since 1990. The accounts started with $100,000 and allocated 10% per trade. The results are probably somewhat predictable (i.e. buy and hold wins). The more we were in the market, the higher the net profit. If I shortened the moving average period to 50 for example, I'm in and out of the market more (but actually in the market more), which gave me a higher net profit than say if I tested against a 150 day simple moving average. What is a bit interesting is that my drawdown with the shorter moving average was lessened (from 50.3% to 37.31%) with a higher net profit. For comparison sake, the drawdown on the 150 day SMA was 47%.

This may be a great way to lessen your drawdown (but boost your transaction costs). If your only goal is to underperform the market with less volatility, might I recommend increasing your bond allocation?

I submit for your perusal the raw results of SMA 150 and SMA 50 system runs. I didn't include 100 because as you might guess, it's somewhere in the middle and not all that interesting. Tests were performed using RightEdge v1.1 using the MovingAverageHold system.

First, SMA 150

click to enlarge

And Now, SMA 50