Do Moving Average Strategies Really Work?

August 19, 2014

by Paul Allen

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Moving-average-crossover strategies have worked out very well in recent years. They prevented their followers from being invested in equities during the tech bubble and the financial crisis. Nevertheless, most of those strategies have underperformed the broad equity market since 2009. In this article, I will analyze all possible moving-average-crossover signals for the S&P 500 since 1928, to see if these strategies provide any value for investors.

Introduction

Mebane Faber’s 2007 paper “A Quantitative Approach to Tactical Asset Allocation“ has become quite popular among the investment community. In this paper, he demonstrated that a very simple 10-month moving average could be used as an effective investment strategy. To be more precise, Faber used a 10-month moving average to determine if an investor should enter or exit a position within a specific asset class. When the closing price of any given underlying closes above its 10-month moving average (10 months is approximately 200 trading days), the investor should sell, and when the price closes below the 10-month moving average, the investor should buy. As this strategy has worked out very well in the past and is very easy to follow, many investors have adopted similar moving-average-crossover strategies for their personal portfolios. A lot of articles have been published about how to apply or improve on Faber’s ideas.

Another famous moving-average-crossover pattern is called the “golden cross.” It occurs when the 50-day moving average of a specific underlying security crosses above its 200-day moving average. The claim is that this signifies an improvement in the underlying trend structure of any given security. Investors should move into cash if the golden cross turns into a “death cross,” in which the 50-day moving average crosses above the 200-day moving average. Within the last decade, most of those moving-average-crossover strategies have worked out very well, as shown in the chart below. This was mainly because those moving average strategies prevented their followers from being invested in equities during the tech bubble and the financial crisis.

Moving Average

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