The S&P 500 Index ($SPX) crossed its 200-day simple moving average (SMA) for the 173rd time since 2000 and the performance for this “signal” is not that great. Buying and selling the 200-day SMA cross produced a lower return than buy and hold. This cross, however, did manage to curtail the drawdowns. Chartists can improve performance by taking it a little slower and adding a signal filter. We will look at some chart signals first and then quantify performance for these signals.
The chart below shows the $SPX with crosses of the 200-day SMA highlighted in blue. The indicator window shows the percentage difference between the close and the 200-day SMA. The indicator turns green with a close above the 200-day SMA and red with a close below it. So far this year $SPX crossed the 200-day SMA twelve times. And there were 22 crosses since 2020. Talk about whiplash.
CHART 1: 200-DAY SMA CROSSES IN THE S&P 500 INDEX ($SPX). Here you see how many times $SPX crossed the 200-day SMA (blue highlights). The indicator below turns green when $SPX is above the 200-day SMA and red when $SPX is below the 200-day SMA. Chart source: StockChartsACP from StockCharts.com. For illustrative purposes only.
Chartists, and cowboys, can improve performance by slowing down a little and smoothing the close with a five-day SMA. The next chart shows the five-day SMA in green and the 200-day SMA in red. Note that the five-day SMA crossed the 200-day SMA just seven times since 2020. Five crosses occurred this year, which shows just how noisy it’s been in 2022.
CHART 2: FIVE-DAY SMA AND 200-DAY SMA CROSSOVERS. There were five crosses this year, which is an indication of how noisy the stock markets have been this year. Chart source: StockChartsACP from StockCharts.com. For illustrative purposes only.
The indicator window shows the percentage difference between the 5- and 200-day SMAs, and the crosses. Notice that I added lines at +1% and -1% as a signal filter. A bull signal triggers when the five-day is at least 1% above the 200-day and a bear signal triggers when the five-day is at least 1% below the 200-day. This filter further reduced whipsaws and improved performance. This indicator is part of the TIP Indicator Edge plug-in for StockChartsACP.
Backtesting Results
Now let’s quantify these signals. The table below shows backtest results for buy-and-hold, the 200-day SMA cross, 5/200 day cross, and the 5/200 day cross with a 1% filter. Buy-and-hold produced a compound annual return (CAR) of 4.54% since 2000 and the average drawdown was 37%. The drawdown is the decline from peak to trough in portfolio equity.
CHART 3: BACKTESTING RESULTS. Smoothing the close with a five-day SMA and adding a 1% signal filter reduced the whipsaws which can better help with broad market timing. Source: Amibroker. Data source: Norgate Data. For illustrative purposes only.
Notice that the number of trades decreased as I smoothed the close with a five-day SMA and then added a 1% signal filter (blue shading). Each step increased the win% and average gain. The CAR for the 200-day cross (3.87%) was lower than buy-and-hold because of all the whipsaws. The 5/200 SMA cross outperformed buy-and-hold with a lower average drawdown and the 1% filter increased the return with a small increase in the drawdown (orang shading).
The Takeaway
Not so fast with crosses of the 200-day SMA. Take a step back by smoothing the close with a five-day SMA and adding a 1% filter for signals. This won’t necessarily eliminate whispsaws but it will reduce them and help with broad market timing. The S&P 500 Index provides an important clue to the overall health of the stock market and we should pay attention.
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