I’ll put this granddaddy to the test against a classic trend-follower, 50/200-day moving average crossovers, here.
Strategy Rules:
Dk applied the strategy to the Nasdaq Composite and I’ll do the same here:
- Go long at today’s close if both the 5 and 10-day exponential moving average (EMA) cross above the 20-day EMA.
- Close the position at today’s close when both the 5 and 10-day EMA cross below the 20-day EMA.
This strategy does NOT go short.
click to enlarge
[logarithmically-scaled]
The graph above shows the Nasdaq (blue) versus the 5-10-20 strategy (red) from 1972. This test is frictionless and assumes a return on cash equal to half the nearest 3-month treasury yield.
And for the number-lovers:
click to enlarge
Over the last 37 years, this strategy significantly increased returns and reduced drawdowns and downside volatility with relatively low turnover (4.4 round-trips per year). It hasn’t been a magic bullet, underperforming the market in 16 of those years, but it has sidestepped every major bear turn, including our most recent.
To illustrate, the next graph shows historical drawdowns over the same period for the strategy (red) vs the index (blue).
click to enlarge
Finally, the last graph below shows that the 5-10-20 strategy (red) has been much more effective than the classic 50/200-day EMA crossover approach (blue) on this particular index.
click to enlarge
[logarithmically-scaled]
Granddaddy? Maybe a bit much. Very good? Most definitely.
In a follow up post I’ll look at the 5-10-20 strategy applied to the Nasdaq 100 (which traders would be much more likely to trade than the full composite) as well as the S&P 500.
Stay tuned, there's more to follow.
[Geek note: There are two generally accepted methods for calculating an EMA that produce slightly different results. DK’s strategy is using the (2 / (Period + 1)) method. If your charting program uses the ((1 / Period) * 2) method, simply increase my period by one. For example, if I’ve used a 10-day EMA, the alternate EMA would use an 11-day EMA.]
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This article has 7 comments:
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Roger Knights
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280 Comments
Dec 02 06:42 AM-
Roger Knights
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280 Comments
Dec 02 06:46 AMSay, maybe some clever, out-of-work hedgie will offer an ETF that trades the market (shorting optional) using this formula plus "Sell in May, buy after Halloween." It would be more attractive to many potential investors, including some institutions, than a simple index fund. Expenses and headaches should be low, and the administrator could do well by doing good.
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Michael S
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3 Comments
My Website
Dec 02 10:21 AMOf course, it would be a tiny bit more difficult because you would have to know prior to the fund's cutoff time the closing price (and hence the direction to be taken at the close), but with a little bit of mathematical horsepower this wouldn't be too difficult to get right about 99% of the time.
Just some random thoughts.
Michael
On Dec 02 06:46 AM Roger Knights wrote:
> Too bad no fund has been modest enough to let such a formula do its
> work.
>
> Say, maybe some clever, out-of-work hedgie will offer an ETF that
> trades the market (shorting optional) using this formula plus "Sell
> in May, buy after Halloween." It would be more attractive to many
> potential investors, including some institutions, than a simple index
> fund. Expenses and headaches should be low, and the administrator
> could do well by doing good.
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John Lounsbury
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606 Comments
My Website
Dec 02 10:29 AM1. How would going short change the outcome?
2, How would using the new ultra ETFs (double long and short) perform?
3. How would T+3 delays affect a long and short strategy?
Do you plan to look at these variations? If you are doing this work soon, I'll wait for your results. If you do not have such plans, I'll take a stab at it myself.
Again, this is outstanding analysis. Thanks.
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jegan ;-)
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762 Comments
Dec 02 01:13 PMGoing short on the downside or using the Ultra ETFs would bump up volatility considerably, but overall should increase returns.
For the record, Dr. Shapp at adxcellence.com has a similar system using the MA50 and RSI. If you are interested in the above program, I heartily suggest checking out his site and signing up for his emailed weekly blog.
If you like what you see, he has two books and a CD. I'd suggest buying the 50-50 plan at about $90 particularly if you are new to investing. It covers everything about the market in simple terms, why it moves, who moves it, how to perform a 1 minute fundamental check on a stock.. etc... etc... Great book. Don;t buy the CD on 'Pivots' (Sorry Dr. Schaap..) .. You can find this info on Investopedia.com and elsewhere.
jegan
jegan
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MILESCFA
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34 Comments
Dec 02 01:52 PMIf you've never worked with mechanical trading strategies, something like this analysis looks great.... on paper. A lot can depend on what you ASS-U-ME: How much capital is required? What is the commission rate? What the slippage (difference between model "buy" and "actual buy", which can depend on both the bid-ask spread and timming differences between the model and actual)?... etc. Also, how are the returns distributed (which impacts the Sharpe Ratio)?
I attempted to produce the "equity curve" chart using this methodology in TradeStation, one of the best known software packages capable of programming mechanical trading strategies. My equity curve was not "as pretty".
In essence, my results showed a profit since 1971 of ~$3500, but importantly, 2 trades in the late 1990's generated $2,100 of the $3,500. Consequently, the equity curve I produced was "unimpressive&quo... EXCEPT the POP due to these 2 trades.
The "annual rate of return" depends on the capital you say is required. I said $110 (Ndx composite in 1971) and the return was about 9.2%, better than the ~7% buy and hold, but not much better considering trading costs (commission, slippage). Notably, the Sharpe Ratio TradeStation produced was barely positive (0.14).
In the end, perhaps the "best measure" of this strategy is this: They have ETFs fro EVERYTHING these days. Anybody know a 5-10-20 ETF?
(PS: I did a long AND SHORT also, the shorts generated an additonal $1,300, raising the rate of return to 10%, still not that impressive).
======================...
On Dec 02 10:29 AM jlounsbury59 wrote:
> I much appreciate top technical analysis like this. Some other ideas
> to investigate....
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bigmoney
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71 Comments
Dec 03 06:09 PMI attempted my own custom mechanical trading strategy this past year. Unfortunately, I deployed in Sept of 07. I made nice cap gains through December, but then it all fell through the floor along with the rest of the market. One problem I had is lack of time, so my "system" suffered serious slippage, both on buy & sell. The original idea was to replace emotions with computer algorithm, but that was better in theory.
To top it off, I payed a mountain of cap gains taxes to the IRS for 2007. Only to loose all that, and (much) more 2008.