Last week I shared a backtest conducted to assess the merit of the 50-day moving average. You’ll want to read it as a precursor to today’s discussion.
You’ll recall the following graphic shared the number of winning and losing signals for each year as well as the total Profit/Loss:
I highlighted 2000 in red because it generated the worst overall performance. In contrast, 2008 was the best. Let’s explore why the signals were so good in one year, while being so terrible in the other.
Consider first, the 2008 SPY chart below with highlighted crossovers:
Can you tell why the 50-MA provided such good signals? Because the market was trending! Simply put, moving average trading systems shine in trending markets. If a stock experiences strong follow through after breaking above or below the 50 MA, this approach is a veritable ATM machine. Since the rules dictate one is always long or short the market, it allowed unfettered participation in the lion’s share of 2008’s sell-off.
Now, if the 50 MA is most effective in trending markets, then how do you think it will fare in non-trending markets? Might this be the trouble with its performance in 2000? Let’s see.
The first two-thirds of 2000 were a veritable chop-fest littered with false signals. Though the last few months produced solid profits for a short trade, it wasn’t closed until early 2001. The takeaway is clear: Range-bound markets are the Achilles heel of this strategy.
Unfortunately, it’s difficult to consistently forecast whether the market will exhibit trending or range-bound behavior. Thus, the hope with the 50 MA strategy is that the drawdowns incurred during choppy market are overcome by the profits captured once prices start trending again. That hope certainly bore fruit over the decade studied. Whether it remains as potent going forward remains to be seen.
Legal Disclaimer
Tackle Trading LLC (“Tackle Trading”) is providing this website and any related materials, including newsletters, blog posts, videos, social media postings and any other communications (collectively, the “Materials”) on an “as-is” basis. This means that although Tackle Trading strives to make the information accurate, thorough and current, neither Tackle Trading nor the author(s) of the Materials or the moderators guarantee or warrant the Materials or accept liability for any damage, loss or expense arising from the use of the Materials, whether based in tort, contract, or otherwise. Tackle Trading is providing the Materials for educational purposes only. We are not providing legal, accounting, or financial advisory services, and this is not a solicitation or recommendation to buy or sell any stocks, options, or other financial instruments or investments. Examples that address specific assets, stocks, options or other financial instrument transactions are for illustrative purposes only and are not intended to represent specific trades or transactions that we have conducted. In fact, for the purpose of illustration, we may use examples that are different from or contrary to transactions we have conducted or positions we hold. Furthermore, this website and any information or training herein are not intended as a solicitation for any future relationship, business or otherwise, between the users and the moderators. No express or implied warranties are being made with respect to these services and products. By using the Materials, each user agrees to indemnify and hold Tackle Trading harmless from all losses, expenses, and costs, including reasonable attorneys’ fees, arising out of or resulting from user’s use of the Materials. In no event shall Tackle Trading or the author(s) or moderators be liable for any direct, special, consequential or incidental damages arising out of or related to the Materials. If this limitation on damages is not enforceable in some states, the total amount of Tackle Trading’s liability to the User or others shall not exceed the amount paid by the user for such Materials.
All investing and trading in the securities market involves a high degree of risk. Any decisions to place trades in the financial markets, including trading in stocks, options or other financial instruments, is a personal decision that should only be made after conducting thorough independent research, including a personal risk and financial assessment, and prior consultation with the user’s investment, legal, tax, and accounting advisors, to determine whether such trading or investment is appropriate for that user.
