Timing the Market with a Combination of Moving Averages

Abstract

A combination of simple moving average trading strategies with several window lengths delivers a greater average return and skewness as well as a lower variance and kurtosis compared with buying and holding the underlying asset using daily returns of value-weighted US decile portfolios sorted by market size, book-to-market, momentum, and standard deviation as well as more than 1000 individual US stocks. The combination moving average (CMA) strategy generates risk-adjusted returns of 2% to 16% per year before transaction costs. The performance of the CMA strategy is driven largely by the volatility of stock returns and resembles the payoffs of an at-the-money protective put on the underlying buy-and-hold return. Conditional factor models with macroeconomic variables, especially the market dividend yield, short-term interest rates, and market conditions, can explain some of the abnormal returns. Standard market timing tests reveal ample evidence regarding the timing ability of the CMA strategy.