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 35 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.
Comments
Didn't Investor give us heads-up on this paper early last year? Although I think the version then was called something like "Fooled by Data-Mining."
Professor Zakamulin was very much inspired by “Data-Mining Bias: The Fool’s Gold of Objective Technical Analysis, Chapter 6,” in text “Evidence-Based Technical Analysis,” by David Aronson. I found some of the analogies used in the book pretty funny...inspired my avatar!
When I ran the numbers, over 100 years or so, I reached same conclusions as Mr. Faber. That SMA absolutely increased risk adjusted returns and substantially reduced drawdowns, which is one of the most important benefits.
When I asked the professor about it, what became evident to me was that he just does not believe 100 years is a long enough period to make a determination. Or, just because it worked in the last 100 years does not mean it will work in next 100 hundred years.
So, I think it remains one of those never-ending debates.
One other word of caution. I like “Social Science Research Network,” but believe it does not provide any peer or editorial review, despite listing names like Professor Fama and Professor Sharpe on its “Board of Directors.” The papers are supposed to have an “academic” style; otherwise, it’s really not much different than posts on say Seeking Alpha.
Hope all is well.
Thank you for the heads-up on several levels.
I was not familiar with MFOer Investors' earlier reference. More importantly, I was not aware that the papers on SSRN are not fully peer reviewed. It appears that the submitted papers are in an intermediate stage along the peer review pathway.
Since I highly value the peer review process, I'm disappointed that SSRN papers have not yet cleared that demanding hurdle. I must be more careful when reading their reports.
I hope you are as well and in as good health as I am. Thank you for asking.
Best Wishes.