Market Timing with Moving Averages (eBook)

Valeriy Zakamulin is Professor of Finance at the School of Business and Law, University of Agder, Norway. He has an M.S. in Business Administration and a PhD in Finance from the Norwegian School of Economics, Norway. He has published articles for various refereed academic and practitioner journals and is a frequent speaker at international conferences. He has also served on the Editorial Board of the Open Economics Journal, Journal of Banking and Finance, and International Journal of Emerging Markets. His current research interests cover behavioral finance, portfolio optimization, time-series analysis of financial data, and stock return and risk predictability.

Preface 7
Motivation for Writing this Book 7
Book Objectives and Structure 10
Readership and Prerequisites 14
Supplementary Book Materials 14
References 15
Acknowledgements 16
Contents 18
About the Author 20
List of Figures 21
List of Tables 29
Moving Averages 31
1 Why Moving Averages? 32
1.1 Trend Detection by Moving Averages 32
1.2 Centered Moving Averages in Time-Series Analysis 33
1.3 Right-Aligned Moving Averages in Market Timing 34
1.4 Chapter Summary 36
References 38
2 Basics of Moving Averages 39
2.1 General Weighted Moving Average 39
2.2 Average Lag Time of a Moving Average 40
2.3 Alternative Representation of a Moving Average 42
2.4 Smoothness of a Moving Average 46
2.5 Chapter Summary 48
Reference 49
3 Types of Moving Averages 50
3.1 Ordinary Moving Averages 50
3.1.1 Simple Moving Average 50
3.1.2 Linear Moving Average 51
3.1.3 Exponential Moving Average 57
3.2 Moving Averages of Moving Averages 62
3.2.1 Triangular Moving Average 62
3.2.2 Double and Triple Exponential Smoothing 64
3.3 Mixed Moving Averages with Less Lag Time 65
3.3.1 Zero Lag Exponential Moving Average 66
3.3.2 Double and Triple Exponential Moving Average 70
3.3.3 Hull Moving Average 72
3.4 Chapter Summary 73
References 79
Trading Rules and Their Anatomy 80
4 Technical Trading Rules 81
4.1 Trading Signal Generation 81
4.2 Momentum Rule 82
4.3 Moving Average Change of Direction Rule 83
4.4 Price Minus Moving Average Rule 84
4.5 Moving Average Crossover Rule 86
4.6 Using Multiple Moving Averages 87
4.7 Moving Average Convergence/Divergence Rule 89
4.8 Limitations of Moving Average Trading Rules 91
4.9 Chapter Summary 94
References 95
5 Anatomy of Trading Rules 96
5.1 Preliminaries 96
5.2 Momentum Rule 98
5.3 Price Minus Moving Average Rule 99
5.4 Moving Average Change of Direction Rule 104
5.5 Moving Average Crossover Rule 108
5.6 Moving Average Convergence/Divergence Rule 114
5.7 Review of Anatomy of Trading Rules 116
5.8 Chapter Summary 119
References 126
Performance Testing Methodology 127
6 Transaction Costs and Returns to a Trading Strategy 129
6.1 Transaction Costs in Capital Markets 129
6.2 Computing the Returns to a Trading Strategy 131
6.3 Chapter Summary 133
References 133
7 Performance Measurement and Outperformance Tests 135
7.1 Choice Under Uncertainty and Portfolio Performance Measures 135
7.1.1 Mean Excess Return 137
7.1.2 Sharpe Ratio 138
7.1.3 Sortino Ratio 141
7.2 Statistical Tests for Outperformance 143
7.2.1 Estimating Performance Measures 143
7.2.2 Formulating the Outperformance Hypothesis 144
7.2.3 Parametric Tests 145
7.2.4 Non-Parametric Tests 146
7.3 Chapter Summary and Additional Remarks 149
References 151
8 Testing Profitability of Technical Trading Rules 153
8.1 Problem Formulation 153
8.2 Back-Testing Trading Rules 154
8.3 Forward-Testing Trading Rules 157
8.4 Chapter Summary and Additional Remarks 161
References 163
Case Studies 165
9 Trading the Standard and Poor's Composite Index 166
9.1 Data 166
9.1.1 Data Sources and Data Construction 167
9.1.2 Descriptive Statistics and Evidence for a Regime Shift 168
9.2 Bull and Bear Market Cycles and Their Dynamics 173
9.3 Reducing the Dimensionality of Testing Procedure 178
9.3.1 Does the Choice of Performance Measure Influence the Selection of Trading Strategy? 179
9.3.2 To Short or Not to Short? 182
9.3.3 Does the Choice of Moving Average Influence the Performance of Trading Strategy? 185
9.3.4 A Brief Summary of Results 188
9.4 Back-Testing Trading Rules 188
9.5 Forward-Testing Trading Rules 195
9.5.1 Forward or Walk-Forward? 195
9.5.2 Ambiguity in Performance Measurement 199
9.5.3 Main Results of Forward Tests 202
9.5.4 Performance over Bull and Bear Markets 206
9.6 Daily Trading the S& P Composite Index
9.6.1 Data 211
9.6.2 Back-Testing Trading Rules 212
9.6.3 Forward-Testing Trading Rules 216
9.7 Defending the Advantages of the Moving Average Strategy 219
9.7.1 The Use and Misuse of the Sharpe Ratio 219
9.7.2 The Asset Allocation Puzzles 223
9.7.3 The Benefits of the Moving Average Strategy 228
9.8 Chapter Summary 234
References 244
10 Trading in Other Financial Markets 246
10.1 The Set of Tested Strategies and General Methodology 246
10.2 Stock Markets 247
10.2.1 Data 247
10.2.2 Back-Testing Trading Rules 249
10.2.3 Forward-Testing Trading Rules 252
10.3 Bond Markets 256
10.3.1 Data 256
10.3.2 Bull and Bear Market Cycles in Bond Markets 256
10.3.3 Back-Testing Trading Rules 258
10.3.4 Forward-Testing Trading Rules 259
10.4 Currency Markets 261
10.4.1 Exchange Rate Regimes 261
10.4.2 Data and Methodology 262
10.4.3 Back-Testing Trading Rules 264
10.4.4 Forward-Testing Trading Rules 266
10.5 Commodity Markets 271
10.5.1 Historical Background 271
10.5.2 Data and Methodology 273
10.5.3 Back-Testing Trading Rules 274
10.5.4 Forward-Testing Trading Rules 275
10.6 Chapter Summary and Concluding Remarks 279
References 285
11 Conclusion 287
11.1 Anatomy of Trading Rules 287
11.2 Profitability of Trading Rules 292
References 295
Index 297