Does Golden Cross Work
Friend, Nooresh Merani uploaded a video (Youtube Link) where in he literally questions using Golden Cross as a trading / investing tool. While I see loads of skeptics who believe Technical Analysis is Bullshit, I found it disappointing that Nooresh does this since he is a expert in Technical Analysis and runs courses and sells newsletters based on application of Technical Analysis on markets.
Unlike say Elliot or Market Profile, strategies like Moving Average Crossover do not require one’s reading of the charts to decide whether its a Buy or Sell. The strategies that can be tested are generally Binary in nature with clear cut logic behind Buy & Sell which cannot be disputed.
His main reasons for not believing is due to
- Huge Lag between time when market hit a low or high and the Signal
- Whipsaws which eat away a huge chunk of capital
Both indeed are true. Moving Average systems lag and you can never catch the bottom or the top. But as investor, are you looking to buy at bottom / sell at top or looking to maximize the amount of time you can spend in market when conditions are favorable and out of market when its not.
Lags can be removed by using a smaller multiple for crossover, but that in turn means more trades and hence more slippage / transaction cost and taxes. For example, if you were to test the smallest MA cross (3 by 5) on Nifty 50 since 1990, you will get 405 trades (Long only). On the other hand, for a similar time frame, using a higher multiple like the Golden Cross (50 by 200) would have given you just 14 trades.
A simple Buy & Hold from say 15th September 1993 (on Nifty) would have given you 7330 points. On the other hand, if you used a MA Cross such as the Golden Cross, you will have ended up with 6600 points. In other words, it will not be beating the Buy & Hold returns.
But while we are exposed to markets 100% of the time when we do a Buy & Hold, we aren’t when we use a system such as the Golden Cross. In fact, we are in the market for only 60% of the time. In other words, for 40% of the time, your capital can earn at the very least Liquid Bees earnings as it awaits the arrival of the next signal.
But the biggest advantage is that when markets go down like they did in 2000 or in 2008, you shall be sitting pretty in cash. So, while a Buy & Hold investor can reap a bit more, he will also have to endure a lot more pain. How much pain? Well, let this chart show you the same in picture format
The chart above plots the draw-down the equity curve would have faced when you just bought and held (Blue) vs using the Golden Cross (Red).
As you can see, while the Blue lines test the 50% (loss of half the maximum capital reached) multiple times, with a simple system such as the Golden Cross, you are able to avoid the risks with draw-down barely moving above 20%.
The comfort it provides to be sitting in cash when everyone is neck deep in losses and wondering if the world will shut down tomorrow is hard to describe.
Yes, a moving average system may not be the best tool if you are a active trader willing to take big risks and spending time on the screen. For all others though, this provides the simplest way to participate in bull markets as and when they come.
Below is list of all trades that you would have taken if you had used this system (a few theoretically since Nifty did not exist until 1996).
Being a systematic trader, for me the biggest advantage of systems that can be tested and validated is that I can risk big. After all, only way to win big is to bet big and for betting big, you need to be sure the odds are in your favor (not in every trade, but overall).
The current Golden Cross may whip and hit the trader / investor with losses. But, that is the way trend following works. You lose 6 out of 10 trades, but the 4 you win more than make up for the losses. If you are searching for a holy grail, you won’t find it in Systematic Strategies at the very least.
You can get a better return if you go short (instead of staying out of the market) when it crosses down. If you have other long positions (or have money in equity MF for instance) this is actually required to effectively neutralise your position else you’ll remain net long while the market is going down.
Good analysis, keep it up
Thanks for the comment.
No, Death Cross doesn’t work in markets which are positively biased (and most markets are). In Nifty for example, shorting at Death Cross would have cost you 850+ points (+ transaction costs).
Owing to Exit Load, going Neutral in MF’s (Even switching to short term debt funds) can turn out expensive whereas ETF’s provide a much better and easier way to switch.