Back Testing Moving Average Trading:

The technical analyst will use various studies in their work – but the ultimate objective is to determine one of three conditions – is it going up? Is it going down? (and) When will it stop doing that (when will it turn)? Some technical studies will lead – like momentum, relative performance and divergence. Some are coincident – like trend lines and some lag – like moving averages. Simple moving averages are popular but they are lagging trend-following studies and should be used to confirm a trend and not to make a trading decision.

I did some back-testing on the S&P500 using three simple moving averages (SMA) – a 20-day, a 50-day and a 200-day just to see if we could trade on the long side only and beat a buy-and-hold over the same periods. We would sell on a price close below the SMA and buy back in on a close above the SMA.

The 200-day SMA – from 6/30/2006   to 7/11/2014 - buy and hold got us +55% and SMA cross over trading got us +51% over the same period. We had 6 profitable trades out of 16 trades.

The 50-day SMA – from 12/7/2012 to 7/11/2014 – buy and hold got us +39% and SMA cross over trading got us +24% over the same period. We had 7 profitable trades out of a total of 11 trades.

The 20-day SMA – from 11/23/2012 to 7/11/2014 – buy-and-hold got us +   40% and SMA cross over trading got us +17% over the same period. We had 11 profitable trades out of a total of 25 trades.

Conclusion – In and out trading using simple moving averages in an up-trending market is a failed strategy because when we move to cash the market continues higher without us – so we buy low, sell high and buy back even higher. In a down-trending market we sell high, buy low and sell even lower. Next time a look at SMA crossovers.