At the end of The Magic of the Moving Average, I challenged members to find the fallacies of the arguments put forth.

I dissected Goddard’s explanation and presented Woody Brock’s Logical Justification for Active Management. I also pointed out the problems with Theodore Wong’s brute force backtesting using flawed data. We can now thank Felix Salmon for finding out just how large the potential pothole really is:

Michael Stokes has run the numbers, and shows what Haldane’s momentum strategy would look like if you buy and sell at month-end prices, rather than retrospectively at the average price for the month:

Given that the momentum strategy wasn’t very good at outperforming a simple buy-and-hold strategy in the first place, this latest insight I think does a great job of burying it completely.

What’s interesting is that Stokes also waded into the moving average cross debate listed in Part 1, namely Mebane Faber’s The Death Cross, or, Questioning What You Read:

It is fairly simple to test this thesis that “moving averages no longer work since 1990?. Below is a chart of the S&P500 total return vs a timing system that uses the simple 50/200 day SMA crossover mentioned in the article. The portfolio moves into a Vanguard Bond mutual fund when not on a buy signal. Transaction costs and taxes are ignored.

For the purposes of the experiment, it would be more appropriate to move to cash when not in a buy signal to eliminate gains from the bond funds.

The Flaw of Averages

FYI, this is Standford Professor Sam Savage, author of The Flaw of Averages: Why We Underestimate Risk in the Face of Uncertainty.