Technical evaluation – trading based on stock chart patterns – has at all times been a hotly debated investing tactic. Although fundamental analysts may dismiss it as junk science, there are still many proponents in Wall Street’s proprietary trading operations to today.
Resistance levels, support levels, triangle patterns, double tops, head and shoulders patterns, moving averages, etc. are amongst the value patterns that technical analysts can study to predict and benefit from future market movements.
We examined a selected type of technical evaluation – moving averages – to evaluate the way it has performed over the many years.
80s nostalgia?
We constructed two portfolios that took an extended position on the S&P 500 when it traded above its moving average and a brief position when it traded below its moving average. One portfolio was constructed based on a 50-day moving average, the opposite on a 200-day moving average.
As a technique, buying the market on days when it eclipsed its 50-day moving average resulted in day by day average returns of between 0.11% and 0.18% over the six many years examined, with the height within the Nineteen Eighties years was achieved. Buying the market on days when it fell below the moving average resulted in average day by day returns between -0.14% and -0.28, with the most important losses also occurring within the Nineteen Eighties.
To give a way of the magnitudes here, if an investor were to purchase daily the market is above its 50-day moving average within the Sixties and short daily it’s below it This leads to a mean annual return of only around 22%. , while the S&P 500 delivered a geometrical average return of 10% over the last decade. This means an overperformance of 12 percentage points. This outperformance was significant on the 1 percent level in all many years examined.
The 50-day moving average portfolio
| 1960–1969 | 1970–1979 | 1980–1989 | 1990–1999 | 2000-2009 | 2010–present | |
| Average day by day return: Buy above the moving average | 0.11% | 0.14% | 0.18% | 0.17% | 0.17% | 0.15% |
| Average day by day return: Buy below the moving average | -0.22% | -0.14% | -0.28% | -0.20% | -0.22% | -0.20% |
| Difference | 0.33% | 0.29% | 0.46% | 0.36% | 0.39% | 0.35% |
The 200-day long-short moving average portfolio achieved similar, if more subdued, results, with average day by day returns starting from a low of 0.16% within the Seventies to a high of 0.29% within the Nineteen Eighties fluctuated.
The 200-day moving average portfolio
| 1960–1969 | 1970–1979 | 1980–1989 | 1990–1999 | 2000-2009 | 2010–present | |
| Average day by day return: Buy above the moving average | 0.06% | 0.08% | 0.09% | 0.09% | 0.10% | 0.08% |
| Average day by day return: Buy below the moving average | -0.15% | -0.07% | -0.20% | -0.16% | -0.11% | -0.14% |
| Difference | 0.22% | 0.16% | 0.29% | 0.25% | 0.21% | 0.22% |
Of course, moving average traders recommend buying stocks immediately after breaking out or crossing the trend line and selling them as soon as they fall below the trend line. So how has such a “cross-over” strategy worked?
Over the many years, the 50-day long-short moving average strategy produced average day by day returns from 0.44% within the Sixties and 2000s to 0.70% within the Seventies.
50 Day Moving Average: Crossing Over Strategy
| 1960–1969 | 1970–1979 | 1980–1989 | 1990–1999 | 2000-2009 | 2010–present | |
| Average return at some point after crossing below | -0.24% | -0.35% | -0.22% | -0.18% | -0.14% | -0.30% |
| Average return at some point after the above exceedance | 0.20% | 0.35% | 0.31% | 0.40% | 0.29% | 0.22% |
| Difference | 0.44% | 0.70% | 0.53% | 0.58% | 0.44% | 0.52% |
In contrast, the 200-day long-short moving average portfolio returned a day by day average of as little as 0.20% within the Sixties to as high as 0.71% within the Nineteen Nineties.
200 Day Moving Average: Crossing Over Strategy
| 1960–1969 | 1970–1979 | 1980–1989 | 1990–1999 | 2000-2009 | 2010–present | |
| Average return at some point after crossing below | -0.04% | -0.23% | -0.31% | -0.16% | -0.12% | -0.36% |
| Average return at some point after the above exceedance | 0.16% | 0.10% | 0.17% | 0.55% | 0.20% | 0.12% |
| Difference | 0.20% | 0.33% | 0.48% | 0.71% | 0.32% | 0.48% |
Although such moving average strategies have delivered excess returns, this performance is just not without risk. In particular, there is important volatility at the underside of the moving average and, in some cases, skewness. Perhaps the upper returns are compensation to investors for taking up the surplus risk, or perhaps only a type of momentum risk.
All in all, while the returns related to these moving average strategies could also be lower than of their heyday within the Nineteen Eighties and Nineteen Nineties, alpha can still be achieved in our modern markets.
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Photo credit: ©Getty Images / Torsten Asmus
