The Hang Seng Index has been on a strong rebound since the beginning of this year. The 250-day moving average has started to edge up after falling for nearly nine months.
If the uptrend continues, the 50-day moving average will cross above the index’s 250-day moving average, triggering a technical called “the golden cross”. Many investors believe it could mean more gains for stocks in the short term.
Let’s use historical numbers to find out if that’s true.
Since 1970, the golden cross signal appeared 26 times. If we used this as an entry signal, how would such a strategy perform?
If we invested HK$100,000 to buy and sell stocks using the golden cross signal – buy when the golden cross appears, and sell when it reverses, or “the death cross” appears – such a trading strategy would generate a return of over 28 times, or a compound annual growth rate of 7.1 percent, bringing the sum to HK$2.91 million.
That sounds like a decent return. But the simple buy-and-hold strategy would generate a total return of 95 times over the same period, equivalent to a compound annual growth rate of 9.7 percent.
Meanwhile, the Hang Seng Index posted a rally of less than 15 percent in 10 of the cases when a golden cross showed up, implying the upside may not be that much.
Part of the reason is that the market has typically already recovered quite a bit to make the golden cross possible. As such, room for further advance if one gets into the market after the signal comes out could be limited.
Is it possible to modify the trading tactic for better performance?
We can tweak the trading strategy a bit by introducing a stop mechanism and see what happens.
For instance, the compound annual return will improve to 7.5 percent after we add a 15 percent trading stop. But that still can’t beat the buy-and-hold approach, although the risk – measured by the maximum value decline of the investment during the trading period – will decrease.
The full article appeared in the Hong Kong Economic Journal on March 21
Translation by Julie Zhu
[Chinese version 中文版]
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