Hi Guys,
In the 1960s I made investment decisions using Moving Averages as a guide. My bible was the first edition of Edwards and Magee’s “Technical Analysis of Stock Trends”. That tome is still highly regarded.
Keeping charts using pencil and graph paper is an error prone, labor intensive task. I had a few successes and a few failures. After about
5 years, I abandoned the arduous chore and drifted to more fundamentally based analysis.
Over the last decade, technical analysis, and particularly those that are momentum or Moving Average based have enjoyed a resurgence of popularity. One reason is that they worked extremely well in this timeframe.
Moving Averages (MA) over its entire lifetime have experienced checkered outcomes. It doesn’t work for a time, and then yields spectacular rewards. Knowledge of its history, what excess returns, or reduced risk it offers can make you a better informed investor. Depending on your goals, timeframe, and risk profile, you might consider using the MA tool or not. Your choice.
Here is a Link to a recent very serious academic paper that explores “The Real-Life Performance of Market Timing with Moving Average and Time-Series Momentum Rules”:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2242795This paper adds to the extensive body of MA studies preceding it. One goal is to eliminate some data-mining aspects of earlier studies. Another is to incorporate trading cost estimates into its assessments. The study is comprehensive and covers the market period from 1926 to 2012. That’s a lot of history that embodies all kinds of economies and exogenous events.
This 3
5 page report does get a bit mathematically intense in its midsection, but those details can be skipped without compromising an understanding of its findings and the reasons why. In particular read the 4. Discussion section for some practical insights.
For example, the author concludes that MA tactics produce a reduction of roughly 30% in returns volatility (standard deviation) relative to buy-and-hold because that tactic is approximately out of equities and into short-term bonds approximately 30% of the time.
For example, Section 4.2 discusses why market timing strategies sometimes work.
The paper’s overarching conclusion is that: “Our findings reveal that at best the real-life performance of the market timing strategies is only marginally better than that of the passive counterparts.”
In the Conclusions section, the researcher says that: “Our estimates suggest that over a long run investors can expect at best only marginally better risk-adjusted returns as compared to the passive investing. Over a medium run, on the other hand, a stock market timing strategy is more likely to underperform than to outperform the passive strategy. This is because the superior performance of a stock market timing strategy is usually confined to some relatively short particular historical episodes.”
The researcher used the Sharpe ratio to measure risk-adjusted returns. Over the entire study period, MA approaches attenuated returns relative to buy-and-hold. Since MA reduces volatility, it delivered marginally superior risk-adjusted performance. As an investor, we get to choose our own poison. The author concludes with the usual cautionary warning that the past does not necessarily predict the future.
Please enjoy the report.
Best Regards.
