Old School Academics on Moving Average Rules: Remarkable.

Old School Academics on Moving Average Rules: Remarkable.

August 13, 2014 Research Insights, Tactical Asset Allocation Research
Print Friendly
(Last Updated On: January 18, 2017)

Simple Technical Trading Rules and the Stochastic Properties of Stock Returns

Abstract:

This paper tests two of the simplest and most popular trading rules–moving average and trading range break-by utilizing the Dow Jones Index from 1897 to 1986. Standard statistical analysis is extended through the use of bootstrap techniques. Overall, our results provide strong support for the technical strategies. The returns obtained from these strategies are not consistent with four popular null models: the random walk, the AR(1), the GARCH-M, and the Exponential GARCH. Buy signals consistently generate higher returns than sell signals, and further, the returns following buy signals are less volatile than returns following sell signals, and further, the returns following buy signals are less volatile than returns following sell signals. Moreover, returns following sell signals are negative, which is not easily explained by any of the currently existing equilibrium models.

Alpha Highlight:

I’m always interested in anything Josef Lakonishok has written. Why? Well, the “L” in LSV stands for Lakonishok and they managed to create a wonderful business that manages around $100 billion. Not bad.

Lakonishok and his coauthors were academics well ahead of their time. Their paper on simple moving average trading rules was published in the Journal of Finance in 1992. What makes this feat even more amazing is that they were publishing papers in top academic journals on technical trading rules in an environment that was extremely hostile towards all things “chartist.”

A quote from Burt Malkiel’s 1981 Random Walk Down Wall Street says it all:

Obviously, I am biased against the “chartist.” This is not only a personal predilection, but a professional one as well. Technical analysis is anathema to the academic world. We love to pick on it. Our bullying tactics’ are prompted by two considerations: (1) the method is patently false; and (2) it’s easy to pick on. And while it may seem a bit unfair to pick on such a sorry target, just remember: His your money we are trying to save.

The results of the study are below.

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

The authors find that moving average trading rules work pretty well. The best performing rule is actually the 50-day moving average. They also identify that a 1% trading band improves the trading rule across the board.

As a value-investor by nature, reading papers on technical analysis can be a bit gut-wrenching, however, as an evidence-based investor by faith, the results are interesting!

Old School Evidence on a New School Trading Theme


Note: This site provides NO information on our value investing ETFs or our momentum investing ETFs. Please refer to this site.


Join thousands of other readers and subscribe to our blog.


Please remember that past performance is not an indicator of future results. Please read our full disclosures. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. This material has been provided to you solely for information and educational purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources believed by the author and Alpha Architect to be reliable but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission from Alpha Architect.


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.


  • jlivermore

    Wesley – it would be great to see the out of return results for these rules from 1986-2014, if your team gets a chance.

  • yep, working on this–Digging in deep. We’ve done this work in the past, but as I started digging up the older research veins it re-inspired a full-up R&D effort…
    will report…

  • Doug

    Trendfollowing is a close cousin of momentum, so I’m not surprised. Most of the big-money CTAs aren’t surprised, either. John Henry bought the Boston Red Sox with moving averages!

  • So, out of sample, the 1,50,1% rule that was the best during their sample doesn’t work nearly as well out of sample. The 200-day MA works the best on risk-adjusted basis–hence the popularity in modern times. So there are definitely elements of data-mining going on here. All that said, the 1,50,1% does still avoid face-ripping drawdowns. In the sense, these technical rules are highly robust…they consistently prevent investors from eating 40,50,60%+ drawdowns.

  • jlivermore

    Thanks Wesley, really enjoy reading all your research! Not sure if you saw my paper on asset allocation using Fama-French’s HML factor … may be some alpha there! http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2456543

  • jlivermore

    Yes, limiting drawdowns is very important for investor psychology.

  • will investigate and highlight on the blog. looks good to go after a first pass.

  • Steve

    Trend following a close cousin to momentum, but not exactly the same.
    From everything I’ve read, I have come to the conclusion that trend following is for reducing volatility moreso than return enhancement (which momentum gives).

  • Jan Vrot

    I am struggling to replicate your results. Is it possible to share a spreadsheet to see where my error is?