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The work of our very own Wayne Whaley is being featured in the current edition of the Technical Analysis of Stocks & Commodities. His contribution to that fine magazine involves the utility of using the 200 day moving average as a guide to enter and exit the stock market.
First to illustrate why the 200 day moving average is deserving of all the attention bestowed upon it, he looks at the returns for 7 different moving average time periods (readers of this blog got a sneak peak into this study last month!):
At an average annual return of 10.85% the 200 day moving average easily stands out among its peers. But it isn’t enough to topple the 11.5% return provided by a humble buy & hold strategy (with the boost provided by dividends).
When measured solely on total return, the 200-day moving average crossover trading strategy has some utility as a trend-following system, but its total return (9.2%) is comparable to the return of the S&P (8%) over this time period and actually under the S&P buy & hold plus dividends (11.5%) return.
This particular trend-following system has some utility in a long-term trading model but is not the net total solution to trend following and should only be used in combination with other forecasting tools.
While that may be true, I wonder if using leverage would allow for a market beating strategy using the 200 day moving average. Even if we use 1.5 or 2 times leverage (and are willing to stomach the volatility) the returns would handily exceed the buy and hold with reinvested dividends. This would be the quintessential trend trading system and about as simple as you can get.
Father Knows Best
And before you turn up your nose at such a basic trading plan, consider that it really does have merit. One particular stock market newsletter bases its whole strategy on the 39 week moving average. Technically that’s 5 days short of a 200 day moving average but close enough it seems. For the curious, that newsletter would be Richard Fabian’s “Successful Investing”. Unfortunately, his son, Doug Fabian, who took over the newsletter in 1992 has strayed from this simple strategy. His subscribers are poorer for it.
Ned Davis Research Knows Best
In a similar vein, NDR was commissioned to do some backtesting for a strategy that switched between the 200 day moving average and money market funds. For the period from late 1979 to May 2007 (when the study was done) this would have provided you with an 11% return and even more impressive, it would have delivered such return with less volatility than just buy and hold. Also interesting, a long term moving average strategy would perform better during volatile time periods like the decade we just went through than smooth ones like the 1990’s. Find out more about Fabian, the NDR study and the 200 day moving average as a signal from this article by Hulbert.
A related area ripe for exploration would be the “Golden Cross” (where the 50 day moving average closes above the 200 day moving average. This similarly simple strategy also has ample historical evidence of profitability.
This gives me even more confidence that exploring the use of leverage with such a strategy would be the smart way to go. Oh, before I forget, you can read Wayne’s complete article here.
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