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Buying and selling based on a moving average of monthly closes can be an effective strategy for
managing the risk of severe loss from major bear markets. In essence,
- when the monthly close of the index is above the moving average value, you hold the index,
- when the index closes below, you move to cash but
- the disadvantage is that it never gets you out at the top or back in at the bottom and
- it can produce the occasional whipsaw (short-term buy or sell signal), which we’ve seen most recently in 2016.
Nevertheless, a chart of the S&P 500 monthly closes since 1995 [see below] shows that a 10- or 12-month simple moving average (SMA) strategy would have ensured participation in most of the upside price movement while dramatically reducing losses.
The original article has been edited here for length (…) and clarity ([ ]) by munKNEE.com – A Site For Sore Eyes & Inquisitive Minds – to provide a fast & easy read.
10 and 12-month Simple Moving Average (SMA) Monthly Closes Since 1995
(Click on image to enlarge)
Here is the 12-month variant:
(Click on image to enlarge)
The 10-month Exponential Moving Average (EMA)
The 10-month exponential moving average (EMA) is a slight variant on the simple moving average. This version mathematically increases the weighting of newer data in the 10-month sequence. Since 1995 it has produced fewer whipsaws than the equivalent simple moving average, although it was a month slower to signal a sell after these two market tops.
(Click on image to enlarge)
10- and 12-month Moving Averages in the Dow From 1928 to 1940
A look back at the 10- and 12-month moving averages in the Dow during the Crash of 1929 and Great Depression shows the effectiveness of these strategies during those dangerous times.
(Click on image to enlarge)
The Psychology of Momentum Signals
Timing works because of a basic human trait. People imitate successful behavior. When they hear of others making money in the market, they buy in. Eventually, the trend reverses…[and] when the trend reverses, successful investors sell early…
Implementing the Strategy
The strategy is most effective in a tax-advantaged account with a low-cost brokerage service. You want the gains for yourself, not your broker or your Uncle Sam.
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