Sunday, February 04, 2007

Are You Still Using Simple Moving Averages?

If so - why - because everybody else does?

I know some things still require you to use SMA such as Bollinger Band due to its dependency on standard deviation calculations that use the SMA but if you have no real need to do so why are you doing it? People who use the simple moving average are giving money away. And, as always when I make a broad statement like that - unlike Jimmy Crack Corn Pone - I can prove it.

I built a filter that is based on the EMA 21. Then I cloned that filter and changed two lines to base it on the SMA 20, a very popular SMA. Here is the EMA 21 Filter

show stocks where close is between 15 and 35
and average volume(90) > 500000
and close > open
and close 1 day ago > open 1 day ago
and close > close 1 day ago
and close 1 day ago > ema(21) 1 day ago
and low 1 day ago < ema(21) 1 day ago

The other filter was exactly the same except ema(21) is changed to sma(20) in both lines shown.

and close 1 day ago > ma(20) 1 day ago
and low 1 day ago < ma(20) 1 day ago

The filters were back tested with everything held equal and here are the results:

EMA 21 = 61% Win Rate, 1.53 Risk/Reward, and 86% ROI.
MA 20 = 50% Win Rate, .93 Risk/Reward, and -7% ROI.

So just looking at those two results sets, which type of moving average do you think you should use? Just a thought - not actionable - unless you want to stop giving away money.

John Forman said...

I can't help but ask what seems to me a very obvious question. Why did you use two different MA lengths? The results would probably be the same, or very similar, but it seems odd that you would test with different settings.

Red Hue said...

Hey Marlyn,

Interesting you had so much difference there. I must admit though...with all due respect...I would worry that such an overall subtle change (ema21 vs sma20) made such a difference...it would raise red flags in my mind that the approach is not robust enough to work over time?

Red Hue

John - the EMA 20 actually had modestly better results for the test period - But I (and others) use the EMA 21 in our every day trading so I used that instead. The MA 20 is one of the most popular averages and that's why I compared to that rather than MA21. Long story short more people use the MA 20 and EMA 21 than other lengths.

Red - I tested across a number of baselines with this filter changing back and forth from 20 to 21 and so on - I kept getting similar (not equal but similar) results - i.e. the EMA outperformed. The ROI's varied (but an SMA ROI was never greater than an EMA's and most often half or worse). But the win percentages remained consistent - 60's for EMA - 50 or less for SMA.

As I said in reply to John - the SMA 20 is one of the most popular moving averages out there and my purpose in the post was to get people thinking about such mundane things as the type of moving average that they use in their own TA.

I generally try a number of standard (to me) approaches in my filters including changing EMA to MA where appropriate - I seldom have had an MA based filter outperform the EMA. And when it has the results were at the 50-50 level which I consider mostly luck and so I discard the filter.

Bullish Jim said...

You've convinced me in theory at least. More and more I'm finding myself fiddling between EMA and SMA when I'm looking at specific stock charts. I don't know how to explain it but some stocks I look at just seem to find support consistently at SMA rather than EMA.

Does your preference for EMA hold true for any time frame? I've always dabbled with the 10, 20, 50, and 200 day SMA for some reason (I don't even remember where I learned it) and I'd be curious which EMAs you use to correspond to each of these approximate time periods.

My ingrained skepticism toward technical analysis in general- admittedly I still fight it- tells me that whichever is used more (EMA or SMA) will result in the best results. The thinking being that if enough people believe it is so then it becomes a self-fulfilling prophecy. I still find B-school getting in the way of my investing quite frequently, obviously. :)

Red Hue said...

Thanks for the info Marlyn...it is intersting that the ema consistently does a little better...proabably due to what you mentioned...getting in just a bit earlier.

Red Hue

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QUALITY STOCKS UNDER 5 DOLLARS said...

Everything averages out.

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