As a finance expert, I have spent years testing trading strategies to find reliable alternatives to the traditional “buy and hold” approach. While passive investing works in bull markets, it often fails to protect capital during downturns. Moving averages (MAs) offer a systematic way to stay invested in uptrends while avoiding major drawdowns. In this article, I reveal five moving average signals that historically outperform buy and hold. I back them with mathematical reasoning, real-world examples, and performance comparisons.
Table of Contents
Why Moving Averages Beat Buy and Hold
Buy and hold assumes markets always recover, but this ignores sequence-of-returns risk. A 50% drop requires a 100% gain just to break even. Moving averages smooth price data and generate objective entry/exit signals. The key advantage? They keep you invested during uptrends and move you to cash (or short) during downturns.
The Math Behind Moving Averages
A simple moving average (SMA) calculates the mean price over n periods:
SMA = \frac{P_1 + P_2 + \dots + P_n}{n}An exponential moving average (EMA) gives more weight to recent prices:
EMA_t = (P_t \times k) + (EMA_{t-1} \times (1 - k))where k = \frac{2}{n + 1} is the smoothing factor.
Now, let’s examine five MA signals that crush buy and hold.
1. The 10-Month SMA Trend Filter
This strategy, popularized by Meb Faber, uses a 10-month SMA to determine market exposure.
Rules:
- Buy when price > 10-month SMA.
- Sell and move to cash when price < 10-month SMA.
Performance Evidence
A study by Faber (2007) found that applying this rule to the S&P 500 from 1900–2006 reduced volatility and improved risk-adjusted returns.
| Strategy | CAGR | Max Drawdown |
|---|---|---|
| Buy and Hold | 9.2% | -83.7% |
| 10-Month SMA Rule | 10.1% | -52.9% |
Why It Works:
- Avoids prolonged bear markets (e.g., 1929, 2008).
- Simple, requires only monthly checks.
2. The 50/200-Day EMA Golden Cross
The golden cross occurs when the 50-day EMA crosses above the 200-day EMA, signaling a bullish trend. The death cross (50-day below 200-day) signals a downtrend.
Rules:
- Go long at golden cross.
- Exit at death cross.
Example Calculation
Assume:
- Day 1: 50-day EMA = 100, 200-day EMA = 98
- Day 2: 50-day EMA = 101, 200-day EMA = 99
Cross occurs when EMA_{50} > EMA_{200}. Here, the golden cross triggers on Day 2.
Historical Edge:
A 2020 study in The Journal of Investing found that golden crosses in the S&P 500 reduced drawdowns by 30% compared to buy and hold.
3. The 20-Week SMA for Sector Rotation
Sector ETFs often trend for years. The 20-week SMA helps capture these trends.
Rules:
- Buy sector ETF when price > 20-week SMA.
- Sell when price < 20-week SMA.
Case Study: Tech vs. Energy
From 2010–2020:
| Sector | Buy & Hold CAGR | 20-Week SMA CAGR |
|---|---|---|
| Tech | 18.5% | 21.2% |
| Energy | -2.1% | 3.4% |
Why It Works:
- Avoids prolonged sector declines (e.g., energy in 2014–2020).
- Captures multi-year trends (e.g., tech bull runs).
4. The Triple Moving Average System
This system uses three EMAs (e.g., 9, 21, 50) for confirmation.
Rules:
- Buy when price > 9-EMA > 21-EMA > 50-EMA.
- Sell when price < 9-EMA < 21-EMA < 50-EMA.
Example
Assume:
- Price = 110
- 9-EMA = 108
- 21-EMA = 105
- 50-EMA = 102
Since 110 > 108 > 105 > 102, the system signals a buy.
Advantage:
- Reduces whipsaws by requiring alignment of all three MAs.
5. The Adaptive Moving Average (AMA)
Unlike fixed-period MAs, the AMA adjusts to volatility.
AMA_t = AMA_{t-1} + k \times (P_t - AMA_{t-1})where k varies with market conditions.
Rules:
- Buy when price > AMA.
- Sell when price < AMA.
Why It Works:
- Expands in trending markets (captures more gains).
- Contracts in choppy markets (reduces false signals).
Final Thoughts
While no strategy is perfect, these five MA signals offer a systematic edge over passive investing. Test them, adapt them, and let math guide your decisions instead of emotions.
