Dear Mr. Wong:
I have enjoyed and appreciated the rigor of your three articles examining the advantages associated with a moving average trading strategy. You have made some very valuable contributions by questioning the popular theology of buy-and-hold investing. I would encourage a similar examination of using a moving average system with bonds and/or a small set of investable assets. My research indicates that beating the S&P 500 total return is relatively easy on an absolute and risk-adjusted basis.
I really appreciate the Advisor Perspectives newsletter. In a world of "junk" newsletters, it is consistently an island of valuable information!
Thank you again for you contributions!
Timothy J. Mowrey, CFP®, AAMS
Mowrey Investment Management
I read your latest piece. One thing I talk about when discussing active management is that the "world of finance" tends to focus on diversifiable or non-systematic risk. Generally during bull markets it works. However, in bear markets, correlations move quickly toward one, which greatly reduces the advantages of diversification. Active management gives equal, if not more, focus on systematic risk. In the grand scheme of risk, systematic risk is considerably the larger of the two.
Chief Technical Analyst
Stadion Money Management
Ted Wong replies:
You are absolutely correct. Someone did a study awhile back (I don't recall who) showing that over 70% of the price movement of a typical NYSE listed stock is tied to the direction of the overall market. Yet, analysts spend all their energy plowing through voluminous financial statements and calculating correlation coefficients just to control the 30% non-systematic risk. The random walk doctrine misled people to forgo the management of the 70% non-diversifiable risk. Anyone who tries to manage the 70% market risk is called market timers - a term synonymous to con artists if not outright criminals.
Great job on the articles – the explanation is clear and concise. I will enjoy sharing them with my clients.
Couple this with truly active management, and you have the makings of a great portfolio.
Matt Armistead, CIMA, CFPÒ
Camelback Wealth Management, LLC
Phoenix, AZ 85016
I just read Part 3 and enjoyed it very much. Several months ago I started building my own spreadsheet and I am using daily S&P500 data from MSN Money back to 1960. My results are similar to yours but I am still working out some kinks.
Here’s what I am working on now:
- My daily analysis provides too many buy/sell transactions. I’m looking into using hysteresis so that buys are triggered at a different point than sells, thereby hopefully lowering the number of transactions. There are often signals that last for only one day or three days. This isn’t efficient. On the other hand, I wonder if using one-month intervals results delaying the buy/sell signal and losing the opportunity to get in or out of the market quickly.
- I have analyzed decade by decade from 1960 and find that the optimum performance for each decade requires slightly different lengths of EMA. My research will continue.
- My analysis also looks at the difference between what I call a long-term EMA and short-term EMA. For example, for the current decade, the 180-day EMA provides a rate of return of 1.46% versus -3.17% for buy-and-hold. However, if I use the trigger of 180-day EMA minus 20-day EMA, the rate of return increases to 4.28% vs -3.17% for buy-and-hold.
- If this analysis works for the S&P500, shouldn’t it work for small cap, international, and perhaps even bonds? Could all the indices be analyzed to create buy/sell signals for large value, large growth, small value, small growth, international, commodities, real estate, and bonds? Each asset class would be fine-tuned separately, thereby providing a framework to allow reallocation from one asset class with a sell signal to another asset class with a strong buy signal? If correlations are not 1.0 across all asset classes, perhaps moving out of large cap and into small cap allows the portfolio to continue to participate in different segments of the stock markets. If correlations are high, then move out of all asset classes and into cash.
- I’ve included dividends and money market rates in my analysis but have not addressed taxes. With the buy/sell signals happening at short intervals, it is rare to sell at long-term capital gains rates and normally requires paying taxes at short-term capital gains rates.
One of the benefits of using an EMA strategy is the behavioral finance factor. Even if the EMA returns are the same or slightly lower than buy-and-hold, there are many instances where the client does not have to bear the psychological pain of living through the severe downturns. By avoiding most of the downturn, the advisor can tell the client that they are safely invested in cash or at least not invested in the asset class that is getting destroyed. This pain of loss, affecting people three times as much as the enjoyment of gain, shouldn’t be underestimated.
Keep up the good work and thank you for challenging the status quo.
Would you like to send this article to a friend?Remember, if you have a question or comment, send it to .