Trend Trading: Using Moving Averages. Part 3.

Vladimir Daragan, STTA Consulting Inc.

Many technical analysts recommend using two moving averages to make buy/sell decisions. The most popular are 200 and 50 day moving average combination. The price tend is considered bullish as along as the shorter average is above the longer and vise versa. We will consider crossing points as buy or sell short signals as it illustrated on the figure, where the Dow Jones Industrial Average chart is shown. Changes of a trading capital is shown on the bottom of the figure. It was supposed that the starting capital = $10,000, he brokerage commissions = $10, slippage per trade = 0.1%.

Using fast moving averages helps to smooth price fluctuations and one can hope that the number of false buy/sell signals will be smaller than in case of using price/MA combination for making the trading decisions. However, as one can see from the figure, this method is good only in case of well established trends. When the market is fluctuating around some number the number of buy/sell signal remains too large and numerous bad trades eat our the profits made during "good trends".

Maybe 200 and 50 day moving average are not optimal? We performed computer analysis of trading the Dow for the period from 1975 to 2001 for various periods of the short and long moving averages. The results are presented on the next figure. Different colors show different the relative capital growths: trading capital after 25 year trading using MA divided to the investing capital, i.e. after using buy and hold strategy. It was supposed that initial capital was equal to $10,000, the brokerage commissions = $10 slippage = 0.1 %. 

We varied short (fast) moving average periods form 1 to 50 and the slow (long) periods from 51 to 250 days. One can see that the maximal growth as 0.2. It means that the best strategy using two moving averages produces the result which is 5 times worse than the results of the buy and hold trading strategy.

Conclusion:
We have performed computer analysis of various trading strategies using moving averages. the results for trading  the Dow Jones Industrial Averages for the period form 1975 to 2001 show that there is no strategy using moving averages which is better than the buy and hold strategy.

We would appreciate if someone can find any moving average strategy which is better than the buy and hold strategy for this period of time.