Back Testing Moving Average Trading (2)

Just to review - 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. This time we look at multiple SMA crossovers.

I did more back-testing on the S&P500 using a two simple moving average (SMA) cross-over – in this case a 5 and a 15 period with the difference smooth by 3 and displayed as a histogram. The trading was on the long side only – sell on a negative histogram and buy back on a positive histogram. The objective was the beat a buy-and-hold strategy over the same period.

The 5/15/3 SMA cross-over monthly from 3/29/1991 to 7/11/2014 - buy and hold got us +424% and SMA cross over trading got us +537% over the same period. We had 6 profitable trades out of 6 signals for a perfect trading record.

Conclusion – we know that signals based on price and SMA crossovers generate multiple false signals – but signals based on two or more SMA crossovers generate reliable signals – in this example having us avoid the 2000-2002 and 2008 bears using long term monthly data. Our long term S&P500 chart displayed here clearly plots the 5/15/3 histogram with the buy & sell zones.

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.

Are the shorts wrong on Bombardier?

Once again we look for a potential “Short Squeeze” opportunity which is a situation in which a heavily shorted stock or commodity moves sharply higher, forcing more short sellers to close out their short positions and adding to the upward pressure on the stock – etc,,,

At June 30, 2014 I see that Bombardier Inc (BBD.B) was number two on the list of largest short sales at 56,571,356 shares, up 9,284,819 shares from two weeks ago. Once again we need three conditions that could have the shorts change their minds and decide to cover – or buy back in. We need – lots of shorts, strong relative performance vs. a relevant index, and finally the stock must be out-of-favour.

Our chart today is Bombardier Inc. daily plotted above the broader TSX60 index – and as we can see by the lower relative perform lines the relative perform is bottoming vs. the TSX60 Index. Note also the series of higher lows from February to date. The Bomber like the C-Series – could surprise on the upside.