Some Math Profs aren’t Fond of Moving Average Rules

Some Math Profs aren’t Fond of Moving Average Rules

March 19, 2014 Research Insights
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(Last Updated On: December 15, 2014)

The mathematicians aren’t fond of moving-average trading rules:

For every day in the sample, we can compute one average price of that stock using the previous m observations x_m, and another average price using the previous n observations x_n, where m < n. A popular investment strategy called “crossing moving averages” consists in owning X whenever x_m>x_n. Indeed, since the sample size determines a limited number of parameter combinations that m and n can adopt, it is relatively easy to determine the pair (m, n) that maximizes the backtest’s performance. There are hundreds of such popular strategies, marketed to unsuspecting lay investors as mathematically sound and empirically tested.

Source: http://www.davidhbailey.com/dhbpapers/backtest-pseudo.pdf

The paper offers some neat suggestions related to minimum backtest length and number of trials.

They also have a website: Mathematicians Against Fraudulent Financial and Investment Advice (MAFFIA)

Can you say “GEEK?”

 


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Definitions of common statistics used in our analysis are available here (towards the bottom)




About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.