When looking at performances of stocks and exchange traded funds (ETFs), traders try to decipher the secrets of the moving average (MA) in an attempt to beat the markets. One performance system may hold the key to beating buy-and-hold investing.

The 10-month Moving Average Crossover (MAC) system is an investment strategy that beats buy-and-hold in absolute performance and risk-adjusted return, writes Theodore Wong for Advisor Perspectives. You would usually buy when prices are above the moving average, and sell when prices are below.

Wong compared the performance of MAC and buy-and-hold strategies using Compound Annual Growth Rates (CAGRs) and monthly data spanning the last 138 years for the S&P 500 total return index. The buy-and-hold benchmark provided returns of 8.6% over the period while CAGRs below 11 months consistently beat buy-and-hold.

The MAC system beats buy-and-hold across all MA sections as shown by the risk-adjusted returns using the ratio of monthly CAGR to standard deviations. Both up and down volatility are categorized as risk under standard deviation. The more relevant measure of downside risk is equity drawdown, or the percentage decline from a recent equity peak. Over the 138 year period, buy-and-hold provides a -85% maximum drawdown and an average drawdown of -26%, whereas MAC showed maximum drawdown of -15% and average drawdown of -4%.

In bear markets, the six-month MAC showed the highest CAGR followed by, respectively, buy-and-hold and 23-month MAC, remarks Theodore Wong for Advisor Perspectives. The average drawdown for the six-month and 23-month MAC are 2% and 4%, repsectively. Average drawdown for buy-and-hold was 26%, any drawdown higher than 10% in the 138-year span were rare. The data reveals buy-and-holders could take 10 to 25 years before breaking even.

MAC annual returns were usually higher than buy-and-hold at same levels of risk. In a risk-and-return tradeoff scheme, buy-and-hold style offered no adequate risk premiums to make up for the wide range of volatility.

By comparing monthly performances between MAC and buy-and-hold, the MAC system captures reutrns in bull markets and avoids most bear markets.

Wong’s findings are certainly interesting. We’ve made no secret of our opinion regarding the buy-and-hold philosophy, and we’re clear proponents of trend following with set entry signals and stop losses in place. Whatever signals you choose to follow, be sure that your strategy is firm and adhered to without fail for the best results.

Max Chen contributed to this article.

Tags: ETF 101, Trend Following