Using Moving Averages. Part 2.

Vladimir Daragan, STTA Consulting Inc.

We continue discussion of using moving averages for trading. In the previous paper we showed that using a simple buy/sell signal provides bad results in trading the Dow for the period from 1975 to 2001. The main reason is enormous number of false buy/sell signals arising from the market volatility.

Here we will analyze using double conformation of the buy/sell signals. Let us remind the main definitions.

We use a simple moving averages

MA_n(i) = [P(i) + P(i-1) + ... + P(i-n+1) ] / n

where P(i) are closing prices, n is the moving average period. One can use more complicated definitions of moving averages (exponential, as an example) but the main results and conclusions are not changed much.

Buy signal:           P(i) > MA_n(i)
Sell short signal:  P(i) < MA_n(i)

Here we will analyze the results of trading using double confirmation (double signal)

Buy signal:           P(i) > MA_n(i)   and  P(i-1) > MA_n(i-1)
Sell short signal:  P(i) < MA_n(i)  and  P(i-1) < MA_n(i-1)

i.e. the index price must confirm its bullish or bearish trend two days in a row. It allows to avoid numerous false signals. A trader will save on commissions and slippage. This method is recommended by many technical analysts.

However, trading results can be worse because of smaller price difference of successful trades. What factor is more important? To answer this question we performed a computer analysis of trading the Dow Jones Industrial Average for the period from 1975 to 2001. The results are presented below. We supposed that a trader started with $10,000, brokerage commissions = $10, and slippage = 0.1%.

We showed the relative capital growth: trading capital after 26 year trading using described methods divided to the investing capital, i.e. the capital after using the buy and hold strategy. As you can see using double buy/sell signals provides even worse results then using single signals. Some other procedure of avoiding noise is needed.