The following letters are in response to Ted Wong’s article, Moving Average: Holy Grail or Fairy Tale - Part 2, which appeared last week.
Dear Mr. Wong,
I appreciated the first two parts on your moving average crossover strategy. However, I think that some flaws in your strategy would have to be addressed before initiating its use. In particular, I think that you underestimate the number of crossovers that will occur when the price approaches the moving average. For example, in Part 1 you indicate that a 12-month MAC averages less than one trade a year. In your response in the next issue, you indicate that your calculations were done assuming a trade will be made at the time of the crossover, or at the latest as of the close of that day.
By my calculations, using this strategy from January 2003 until today would have resulted in 40 trades, about six per year. Many of those trades would have been losers as you were whipsawed while the market tried to settle on a new trend. Methods to avoid this would include waiting for a close a certain percentage away from the moving average or waiting for the end of the month your average was broken and initiating your trade on the first of the next month. Either of these methods would obviously have a deleterious effect on your returns. I do not mean to dismiss the use of moving averages, but believe that anyone who plans to use this strategy should be aware of the issues surrounding its implementation
Thank You,
John O'Meara, CFP®
Managing Partner
Inner Harbor Advisors, LLC
New York, NY
Ted Wong responds:
John,
I appreciate your feedback. Many readers raised the same concern regarding whipsaws. I agree with you that the MAC method has many issues in real-life trading. I never intended to suggest that the MAC system is a realistic active management system. I only use it as a simple illustration to compare to the buy-and-hold results. Perhaps I should make this point clear in Part 3 before many advisors hasten to implement the MAC system in their practices.
Thanks for your advice.
Ted
Theodore:
Interesting article and eagerly awaiting Part 3. Your statement:
"Even with the 2-month MA, MAC generates only 0.9 round-trip per year, or a holding period of 1.1 years."
intrigued my curiosity. Your buy sell/rule does not state any convention to avoid nasty whipsaws which seem to prevail in all MA timing signals, and which would dramatically increase round trips. How do you avoid whipsaws and achieve a relatively low turnover with even short (fast) range MA's? Does the answer lie in the apparent two-time period shift of the MA line?
Thank You
Bob Amory
Ted Wong responds:
Bob,Thanks for your comments. The MAC system would no doubt suffer from whipsaws in non-trending markets. But over 138 years, there would have been enough bull and bear phases lasting an extended period of time which, in aggregate, would keep the average holding period down to 1.1 years. But I am sure that in those years when sideway markets prevailed, the 2-month MAC would have more than 0.9 round trips per year.
Hope this helps,
Ted
