Last update: July 2021
In last week’s training on bear market tactics in our Youtube channel (watch now “6 Bear Market Trading Tactics” on YouTube), I discussed the power of using the 50-day moving average as a guide for the intermediate trend. Like railroad tracks bisecting a city, the 50 MA provides a line in the sand to base your directional bias from. When prices are above it, you’re bullish. When they’re below, you’re bearish.
I want to expand on this concept today. First, last year I penned a piece on how effective the 200-day moving average is. Consider it a companion article to this one. Read it here.
A decade ago, I explored the wisdom of using the 50 MA as a signal generator for when to buy and sell. I’m posting some of that piece below.
50-day Moving Average Crosses
Of the many technical indicators available, moving averages have risen as not only one of the most popular, but also one of the most effective. Perhaps their popularity is due in part to their simple yet versatile nature. Traders can use them for anything from identifying trends and reversals to measuring momentum and crossovers. Though you can build moving averages on any time frame, the 50-day moving average has become a staple for most chartists. Indeed, it comes default on most charting platforms and is often used to identify the intermediate trend.
I suspect many traders (myself included) took note last Thursday as the SPY mustered the strength to breach its declining 50 MA. Those subscribing to the notion that the 50 MA provides quality signals likely used this breach as a tell to switch from bearish to bullish.
As with any strategy, however, the proof is in the pudding. If breaking the 50 MA has provided profitable signals in the past, then directional traders ignore this signal at their peril. Thus far, the SPY has seen four different occurrences of breaking the 50 MA in 2010 – all of which proved fruitful.
Admittedly, four signals is too small a sample size to draw any meaningful conclusions. Suppose we looked at the performance of the 50 MA signal going back to 2000. With ten years of data and 70 plus crosses to learn from, we certainly have enough data to pass judgment on whether this moving average is all hype or worth observing.
The Backtest
Equipped with a few simple rules and my semi-adequate Excel spreadsheet skills, I set out to determine whether or not this moving average is worth its weight or just another indicator cluttering up my chart. Before delving into the results, let’s first establish the gist of the trading plan.
- Buy the SPY on a 1+% break above the 50 MA.
- Sell short the SPY on a 1+% break below the 50 MA.
The system says you always have a position (long or short) depending on whether the SPY is above or below the 50 MA. For simplicity purposes, I assumed one was long or short one share of the SPY. To reduce the risk of whipsaw, I required the SPY to break the 50 MA by at least 1% to generate a signal. Settling on a proper filter for a trading system is always a dilemma as there is an inherent trade-off. Though using a break of 0.5% instead of 1% would have generated quicker signals and thus better entry prices, it inevitably would have resulted in more false signals. No price filter will work every time, so it’s really a matter of finding what works best the majority of the time.
The graphic below displays the outcome of the trading system from 2000 to 2010.
The table is broken down into the 50 MA’s performance per year with both the best and worst years highlighted. Of the 71 buy/sell signals I found, 28 were winners, and 43 were losers. At first blush, that doesn’t look so effective, however, it’s not just about the number of wins versus losses. To gain a complete picture, we must also take into consideration the average gains captured on the winning trades versus the average losses incurred on losing trades. Of the 28 winners, $7.61 was the average gain. Of the 43 losers, $2.12 was the average loss. Shown in this light, the trading system looks much more appealing.
Given that I did this by hand, I may have missed a signal here or there or have a few errors in the numbers. Be that as it may, I’m confident it wouldn’t have changed the conclusions we can draw from this whole exercise.
In next week’s post, I’ll compare the best and worst-performing years to hammer out a few strengths and weaknesses of using moving average signals.
Tackle Trading Resources on Backtesting
Why backtesting? What are the benefits? How to run backtesting? How to collect and analyze data? What types of trading systems can I backtest? What are the tools available to run backtests?
These and many other questions have been already answered in our extensive pool of articles on backtesting.
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