Investigation of the potential of the moving average crossover trading strategy : Evaluation of a trading strategy in nine historical time periods

Sammanfattning

The Moving average crossover strategy (MACS) is a widely used technique in financial markets where two moving averages are used to identify trends and make trading decisions. However, the effectiveness of this strategy largely depends on the chosen length parameters for the moving averages. The moving averages identify trends in a market price and help investors decide when to buy and sell. The moving average crossover strategy uses two averages called the short and long moving averages. The long moving average covers a larger timespan compared to the short moving average. The length parameters for the short and long moving averages are usually set to 40 and 140 but they might not necessarily be the most efficient combination. This study is about investigating the potential of the optimal combination of the two length parameters for the moving averages. We evaluate the performance in historical markets based on the net gain in a financial market following a number of trades. In the study we also compare the MACS to the common and usually profitable strategy of simply buying and holding a security in the same timeframe. To optimize the length parameters a digital testing environment is created. The environment takes historical data of market prices during a specific period and applies the MACS with adjustable averages lengths on the data uploaded by the user. The environment then creates a 3D-graph measuring net gain or the net loss, that is the increase or decrease in value of an investment as a function of average length of the two moving averages. Historical data for the S and P 500, gold, and bitcoin are used. After finding the optimal moving average crossover length parameters, the strategy’s net gain is compared to the outcome of buying and holding the security for the same amount of time. The results show that simply buying and holding a security consistently outperforms the moving average crossover strategy when the standard length parameters of 40 and 140 are used, but the MACS using optimal length parameters often outperforms buying and holding. The results also show that the optimal length for the long and short moving averages often are close to one another.