The golden cross is one of the most famous methods of market timing, it is based on 50 day and 200 day moving average. The rules are simple:
- Buy if the 50 day moving average crosses above 200 day moving average.
- Sell if the 50 day moving average crosses below 200 day moving average.
For this test we will use the S&P500 index. Back-testing this simple market timing strategy for the last 5 decades (since 1961) resulted in:
- Annual return of 6.69% (vs. 6.79% buy and hold)
- Max draw-down of -33% (vs. -56% of buy and hold)
- Ulcer index of 8.16 (vs. 16.2 of buy and hold)
- Sharpe of 0.31
We can clearly see that while there was almost no change in annual return we reduced draw-down risk almost by half. Implementing the same strategy on a monthly basis will help us reduce whipsaws and improve performance, these are the results when I used 2 month and 10 month moving average cross.
- Annual return of 7.11% (vs. 6.79% buy and hold)
- Max draw-down of -27% (vs. -56% of buy and hold)
- Ulcer index of 7.1 (vs. 16.2 of buy and hold)
- Sharpe of 0.35