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Moving averages (MAs) are often the first technical indicator learnt when studying technical analysis, and why not they are straight forward and help gauge where a market is in relation to its history. Trends can also be identified by looking at a market’s average.
Having said that, generally trading off moving averages alone does not yield particularly good long-term results. This is because most moving average systems do very poorly during periods of either high volatility or sideways movement. Such periods can create drawdowns large enough to erase all gains or even whole accounts.
So with that in mind it is some recent analysis inspired by Birinyi and Associates www.birinyi.com that is quite surprising. It relates to a pattern known as a Golden Cross. This is the term used to describe a shorter-term moving average crossing above a longer-term moving average. While the two averages can be set to any period, this study focuses on two of the most popular - the 50 and 200 MAs.
Many major indices around the world including the S&P 500 (SPX), Russell 2000 (RUT), Dow Jones (INDU), NASDAQ 100 (NDX), FTSE 100 (FTSE) and ASX S&P 200 (XJO) have recently shown this pattern. Below are some examples.
Chart 1 – SPX - Golden Cross
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Chart 2 – INDU - Golden Cross
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Since the 1929 crash there have been thirty-six 50/200 golden crosses on the daily chart on the Dow Jones Industrial (30) Index. 72% of the time the market was higher 12 months later for an average gain of 10.44%. Over those 12 months the average peak was 17.89% higher than the signal and the average trough was 9.79% lower.
Now there are some important points to note here on the testing approach used. First, the HUBB symbol DJ-CASH was used and like some other Dow symbols (DJX, DIA) at time of writing it is yet to show a cross like that on the INDU symbol above. This means that the test data used to gain the stats above is yet to show a current signal. Note the DJ-CASH was used as it has history back to 1910 on HUBB servers, others do not.
Chart 3 – DJ-CASH – Not Yet!
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Second, only the first golden cross signal was taken each time as this is the one that would have been “traded” when following the market real time. By this I mean that once a signal was given the system would follow it for 252 trading days and ignore any other signals that occurred in that period.
It is also worth noting that the biggest drawdown was -43.38% after the 1937 signal – yes when do we hear about the 1937 crash?? A repeat or similar number would see a new low from current levels. Although a drawdown closer to the average of -9.79% would seem more likely.
So while technically this signal hasn’t been given properly yet, the big positive for any bulls out there is that since 1929, more times than not, the market is higher 12 months later when 50/200 golden cross occurs. If it happens on DJ-CASH I wouldn’t say this is a signal to trade directly, but it certainly makes for a good guide to what may happen over the coming year.
Happy Trading
Jordan Craw
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