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Idea

I wanted to discover if a moving average of the general market or the stock could help improve my trading success. I think the answer is no, they won’t, but the research does reveal important clues.

Methodology

I used most of my stock trades for which there were price data available and the S&P 500 index in the test. This amounted to 323 trades from December 1982 to June 2007. I used 3 exponential moving averages (individually, not in combination) in both the stock and index: 10 day, 50 day, and 200 day, chosen arbitrarily, but they are popular settings.

Test 1 Discussion

I looked at the general market to determine if the market trend before and during the trade influenced the number of winners. It did. The best performance came from the market reversing a downtrend. In other words, the market fell leading to the stock purchase and then was higher on the sale date. The worst performance came when the market dropped, either reversing an uptrend or just continuing lower from the buy date. The following table shows the market direction on the buy and sale date and the percentage of winning trades.

The 10, 50, and 200 MA column headings are the days used in the moving average to gauge the up or down trend of the S&P index.

Row definitions:

Down to up. Reversal: The S&P 500 index trended down into the buy date but closed higher on the sale date.

Up always. Continuation: The index trended upward into the buy date and closed higher on the sale date.

Up to down. Reversal: The index trended upward into the buy date but closed lower on the sale date.

Down always. Continuation: The index trended lower into the buy date and closed lower on the sale date.

You can think of the rows as reversals or continuations of the general market. When the market reversed, it led to better stock performance (more winning trades). When the market continued its trend, fewer winners appeared.

The results suggest that you buy when the market is falling and hold long enough for the market to pull your stock higher.

Test 2 Discussion

In the next test, I counted each profitable trade as $+1 and each losing trade as $-1. This shielded the results from trades with huge profits so that each trade had an equal weight. (I also substituted the actual profits and losses but the results didn’t change). I used the 3 moving averages for the S&P 500 index and mapped whether the total trades (the sum of the +1 and -1 scores) worked better if the average was trending up or down. Unlike test 1, I did not look at the trend of the index on the sale date, only the buy date. The reason for this is you can’t tell what will happen to the market after you buy the stock (such as a 9/11 attack).

I discovered that if the general market (S&P index) trends lower into the trade, then the trade is more likely to be profitable, regardless of which moving average is used. The results cover the entire period from 1982 to 2007, but they are the same if you break them down on an annual basis.

For the bear market in the index (3/24/2000 to 10/10/2002), the results flipped with winning trades occurring more often when the market was trending upward than downward. All trades were from the long side (none were short sales).

Test 3 Discussion

I applied the same technique to the three moving averages (10, 50, and 200-day) for each stock. I determined whether the stock’s moving averages were rising or falling leading into the buy date and looked at the +1/-1 sum of winning trades. I found slightly different results. When either the 10- or 200- day moving averages were trending lower going into the buy, more winning trades occurred. The 50-day moving average showed a rising stock trend having one more winning trade over the declining stock trend.

Test 4 Discussion

The following tables show the percentage of trades having a profit or loss when the various moving averages in the S&P 500 were trending up or down ending the day before I bought the stock. Each quadrant, on average, is worth 25%, so large deviations from that value might mean a statistically significant result. I did not test for statistical significance.

10 day MA	Profit	Loss
S&P trend up	27%	31%
S&P trend down	24%	18%

A falling market resulted in the fewest number of losing trades (between 11% and 18% of the time). A rising market resulted in the most losing trades (between 31% and 38% of the time) but also the most winning ones (between 27% and 35% of the time).

Comparing the three tables shows that as the moving average lengthens (from 10 to 200 days), the number of winning trades increases if the market rises. If the market falls, the number of winning trades decreases as the moving average length increases.

Test 5 Discussion

The following tables show how often the stock was trending up or down (ending the day before the buy) and how often that resulted in a profit or loss. The difference between test 4 and this test is test 4 used moving averages of the S&P 500 index and this test uses the stock’s moving averages.

A stock trending up resulted in a loss between 29% and 34% of the time -- the highest of each group. More trades were profitable when the stock trended lower using either the 50- or 200-day moving averages. The 10-day moving average, when trending upward, lead to more winning trades. A stock trending lower resulted in a loss the fewest number of times (between 16% and 21% of the time).