The Golden Cross

In my readings of many message boards, I’ve noticed on more than one occasion, the cross of the 50 day moving average and the 200 day moving average being referred to as the golden cross.  How golden a cross it is or it isn’t we can find out by performing a simple back test.

Utilizing about 94 years of data on the Dow Jones Industrial Average we will invest $100,000 if the 50 day moving average crosses above the 200 day moving average we buy, when it crosses below we flip the position to the short side.

The average annual return and the risk adjusted average annual rate of return are something short of stellar at 3.4% and 3.44%.  Of course 94 years of compounding makes even a small annual return look outstanding in dollar terms.

Of course the problem with this so-called golden cross is the same problem afflicting most all moving average crossover systems and that is simply a high number of whipsaws experienced during sideways consolidations as the chart above shows so well.

The question of course is not necessarily the return achieved but does this crossover of moving averages present us with an edge?

In attempting to determine if there is an edge we begin by averaging all the maximum adverse excursions (MAE) against the average of all the maximum favorable excursions (MFE).  Doing so with this test there appears on the surface that an advantage does indeed exit.

In order to determine however, if this edge is good we have to take volatility into account.  For the purposes of today’s posting that has not been attempted.