The Faber(2007) article discusses a 200-day simple moving average, which is proposed
in Jeremy Seigel's book "Stocks for the Long Run" (1994) for timing the DJIA. He
concludes that a simple market timing strategy improves the absolute and
risk adjusted returns over a buy-and-hold strategy. After all transaction
costs are included, the timing strategy falls short on the absolute return,
but still provides a better risk-adjusted return. Siegel also tests timing on
the Nasdaq composite since 1972 and finds better absolute and risk adjusted
returns.
The article implements a simpler version of the 200-day SMA, opting for a
10-month SMA. Monthly data is more easily available for long periods of time,
and the lower granularity should translate to lower transaction costs.
The rules of the system are relatively simple:
- Buy when monthly price > 10-month SMA
- Sell and move to cash when monthly price < 10-month SMA
- All entry and exit prices are on the day of the signal at the close.
- All data series are total return series including dividends, updated monthly.
For the purposes of this demo, we only use price returns.
- Cash returns are estimated with 90-day commercial paper. Margin rates for
leveraged models are estimated with the broker call rate. Again, for the
purposes of this demo strategy, we ignore interest and leverage (though these can be modeled in the framework).
- commissions, and slippage are excluded (though they can be modeled in the framework).
- taxes are excluded.
This simple strategy is different from well-known trend-following systems in
three respects. First, there's no shorting. Positions are converted to cash on
a 'sell' signal, rather than taking a short position. Second, the entire position
is put on at trade inception. No assumptions are made about increasing position
size as the trend progresses. Third, there are no stops. If the trend reverts
quickly, this system will wait for a sell signal before selling the position.