Key Points:
- Technical analysis, although debated, has many proponents in Wall Street trading.
- Moving averages are one form of technical analysis that have been examined for their performance.
- Buying stocks above the moving average and shorting them below generated significant excess returns in each decade studied.
- A crossing over strategy, based on moving averages, also produced positive average returns across the decades.
- These moving average strategies come with risk and volatility, but there may still be alpha to be gained in modern markets.
Technical analysis, which involves making trading decisions based on the chart patterns of stocks, has long been a topic of debate among investors. While some dismiss it as junk science, many on Wall Street still believe in its efficacy. This article explores one specific form of technical analysis – moving averages – to determine their performance over several decades.
Moving averages involve calculating the average price of a security over a specified period of time. Traders then use these averages to identify potential buy and sell signals. The article focuses on two moving averages – a 50-day moving average and a 200-day moving average – and examines their performance in generating returns.
When the S&P 500 traded above its moving average, a long position was taken, and when it traded below, a short position was taken. The results showed that buying the market when it was above the moving average generated average daily returns ranging from 0.11% to 0.18% across the decades studied, with the highest returns occurring in the 1980s. Conversely, buying the market when it fell below the moving average resulted in average daily returns ranging from -0.14% to -0.28%, with the 1980s also experiencing the largest losses.
By implementing a “cross-over” strategy, where stocks are bought immediately after breaking above the moving average and sold when they fall below, the results showed positive average returns. The 50-day moving average strategy produced daily average returns ranging from 0.44% to 0.70% across the decades, with the highest returns in the 1970s. The 200-day moving average strategy yielded daily average returns ranging from 0.20% to 0.71%, with the highest returns in the 1990s.
However, it is important to note that these moving average strategies do come with risk and volatility. The crossing below side of the moving average exhibited considerable volatility, and there was skewness observed in some cases. These higher returns may be an investor’s compensation for taking on the excess risk or a form of momentum risk.
In conclusion, while the returns associated with moving average strategies may not be as high as they were in the past, there may still be alpha to be gained in modern markets. These strategies have shown consistent excess returns across the decades studied, indicating their potential value in investment decision-making.
