Strategy Lab: 5-day EMA cross of 10-day EMA

This is another strategy which can be set up using Zignals stock alerts. It's a variation of a moving average strategy published back in May; this time a shorter time frame and more responsive exponential moving average is used to generate trade signals. A 5-day EMA crossover of a 10-day EMA was used to generate trades; buying upside crosses and selling on a downward cross of the slower EMA by the faster one.


Test period: A complete bull-bear cycle defined by the S&P (March 20th 2000 to October 8th 2007).

I tested on two groups of stocks:

US stocks (Active Trader): AAPL BA C CAT CSCO DIS GM HPQ IBM INTC IP JPM KO MSFT SBUX T WMT

European ADRs: ALU BHP BP SAP DT ASML STM BCS UN TOT ELN AZN DEO RYAAY LUX

Invested: $5,000 per trade

Commission: $9.95

Trades: Round-trip only; partial trades were excluded.

As in previous strategy labs, commission costs impacted heavily on net return. For the test period there was a total loss of -$21,683 from 1,385 trades where no stop was used. The most effective stop strategy was 5%, although it only slightly improved the return to a loss of -$15,753.

In the absence of commission there was a significant improvement in the returns.

The European ADRs got a significant bump from Elan Corp (ELN) and SAP (SAP), but returns from European ADRs dropped sharply once a stop was factored in. The most consistent return for US and European stocks grouped together was achieved using a 3% or 4% stop.


Unlike the slower moving average strategy, this exponential moving average strategy was profitable across the majority of stop settings, running second to the MACD strategy with respect to total profit.

How about the performance over three randomly selected test years?

The selected dates covered July 2006/07 (bullish), May 2000/01 (bearish) and May 2005/06 (bullish). There was a slight advantage to using a 4% stop, but the 3-6% stop range generated greater benefits than using no stop at all or using a greater stop.


The real benefits to using a stop were in the details. During the strong bull market of 2006/07 the no stop, 7% and 8% stops produced the highest profit; returning over $10,000 in profit on 171 trades compared to $9,855 with a 4% stop. The bull market of 2005/06 also produced a similar pattern of profits, but on a much reduced scale. However, during the 2000/01 bear market the no stop, 7% and 8% stop strategy posted losses of -$16,295, -$16,663 and -$13,830 respectively compared to only -$3,537 of losses with a 4% stop on 190 trades.

This is a strategy well suited to use with a protective stop. Although one should caution on overconfidence generated from using loose stops (or no stop at all) during rich times.

Feel free to use these stocks in your own Zignals stocklist.

Unfortunately we didn't make the cut for this week's festival of stocks hosted by Circle of Competence.

Dr. Declan Fallon, Senior Market Technician, Zignals.com the free stock alerts, market alerts, and stock charts website
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Strategy Lab: Moving average crossover

In this week's strategy lab I will take a look at a simple moving average crossover system; the strategy involves buying on a bullish cross of a 20-day MA by a 10-day MA and selling on the counter bearish cross. I have included data on two sets of stocks; the Active Trader list of U.S. stocks, and a set of European ADRs listed on U.S. markets.


Stocks:
US stocks: AAPL BA C CAT CSCO DIS GM HPQ IBM INTC IP JPM KO MSFT SBUX T WMT
European ADRs: ALU BHP BP SAP DT ASML STM BCS UN TOT ELN AZN DEO RYAAY LUX

Number of shares: 100

Commission: $9.95 (included in the loss calculation)

Trades: Round-trip only; partial trades were excluded.

The strategy was trade heavy with respect to the total number of trades made, making it unsuitable for a regular commission account. The no-stop crossover system generated 893 trades. Adding a stop did not increase substantially the number of trades the system made:

Profit: -$11,164
Winners: 338
Losers: 555
Win percentage: 38%
Profit factor: 0.88

There was a polar opposite return when this strategy (with zero commission) was applied to U.S. and European stocks. Only the 4% stop loss strategy suggested any relationship between the two groups of stocks:


Without further testing of European stocks it is hard to conclude if there is a meaningful difference in trading quality between U.S. and European stocks - but the discrepancy as shown here is not small. One factor contributing to these findings was the lower liquidity of European ADRs compared to the U.S. test stocks. Another is the frequent gaps commonly found in ADRs traded on U.S. markets. Both factors likely contributed to some of the differences seen here. What works for one set of conditions or stock groups may not work for another, and this must always be in the back of your mind when it comes to the practical application of your strategy.

What of a three, randomly selected, 1-year test periods?

The three periods were November 2006/07, February 2004/05, and November 2007/current day. Only U.S. stocks were tested to keep outputs consistent with earlier strategy lab tests.


Because of the lag characteristics of moving averages, entered trades came a few days after reversal points in the market, so using a broader stop prevented whipsaw from the frequent backtests common after a reversal. Using a stop was more profitable than using the strategy as a 'pure system'; i.e, letting crossovers dicate entry and exit signals only.

The win percentage was respectable, around the 42-43% area.

Moving average trading systems perform very well in strong trending markets. The 2006/07 period was very profitable (with the exception of a 3% stop). Non-trending markets tend to hit the system more in commission costs rather than absolute losses. Using longer moving averages would have resulted in fewer trades and therefore fewer transaction costs and would be more suitable for commission based accounts.

Dr. Declan Fallon, Senior Market Technician, Zignals.com the free stock alerts, market alerts, and stock charts website
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Positive Thinking - Euro style

The US Market is one market subdivided into Bull and Bears, Shorts and longs, optimists and pessimists not to mention 1000+ companies - and nearly as many sectors. BUT one currency.

Europe has most of these characteristics but many markets.
So with 20 +/- markets, all the aspects covered by Jack McHugh as quoted by Barry Ritholtz, "Postive Thinking vs Skepticism in the Markets", are amplified many times over.

Instead of one economy as in US, Europe has many conflicting and divergent economies and (a limited) number of currencies

Cycles occur always and everywhere and do not necessarily converge across economies. I suggest Jack's comment probably has little relevance to the current state of Europe and its markets.

Remember the definitions of Company Reports we saw after Arthur Anderson.

EBIAT - earnings before irregularities and tampering
CEO - Chief Embezzlement Officer
CFO - Corporate Fraud Officer
EPS - Eventual Prison Sentence
NAV - Normal Anderson valuation

On other news:
The latest Strategy Lab article was hosted by StockPursuit.com over the weekend.

Robert Mooney discusses topics around investment strategies, ETF investing and market sentiment for Zignals
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