Market Timing with Moving Average crossovers

"The trend is your friend" or "Never fight the tape" are common expressions to justify investing in trend following market timing systems.

One of the most popular Trend following Timing system is the Moving Average Crossovers.

Simply:
  • buy when a short moving average crosses up a long moving average (Golden Cross)

  • sell when a short moving average crosses down a long moving average (Death Cross)

A common combination is 50 days and 200 days for the short and long Moving Averages respectively. Aggressive investors using the Nasdaq often use shorter Moving Averages such as 25 days and 100 days.


The longer the Moving Averages, the fewer signals will be generated. From 1950 to 2008, the 50/200 Days Moving Averages system just produced 29 Buy and 29 Sell signals on the S&P500 or about 1 signal per year which is pretty low.

An illustration of the benefit of Moving Averages as Timing signal is the Stock Market in the 1970s. Here is how such system would have fared over 1967-1978 period when the S&P500 was going nowhere.


Market Timing with Moving Averages



The system is in Buy mode in the yellow zones. During that 11 years period, the Moving Averages system earned 3% annualized while Buy And Hold earned 0.8%.

Notice how the system never enters the market at bottoms and never exits the market at tops. Moving Averages are trend following systems: they are always late. This system is very effective in powerful trends but ineffective in less pronounced trends because by the time the system gives a signal, the trend may be reversing.

BUT as you can see, even in this 11 years long sideway market, Moving Averages crossover is quite effective. The reason is that even in a long sideway market, intermediate powerful trends will develop.

Benefit of Market Timing with Moving Averages Go back to Top

The system always avoid sharp Bear Markets. That's the beauty of Moving Averages: they will always take you out of the Market before severe losses. The Max drawdown in the above example is -11.1% in 1969 compared to -28.1% for the S&P500 in 1974.

More recently, the 50/200 Days Moving Averages crossover system was completely out of the market in 2001, 2002 and the great 2008 Bear Market when the S&P500 lost -10%, -21.3% and -38.5% respectively !

By avoiding bear markets, Moving Averages provide much better risk adjusted returns (and beter annualized returns) compared to Buy and Hold.

See also:
  • Market Timing performances to check how moving average crossovers compare to other market timing systems.

  • Momentum Stock Picking & Market Timing to improve your Momentum Stock picks with Market Timing based on Moving Averages.





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