The stock market has historically had a bullish bias, yet commonly used moving average crossover systems such as the 50-200 EMA crossover do not take this into account when a buy or sell signal is changing. For a buy signal to be generated, the stock market has to make a move of a similar magnitude as it does to signal a sell. In my opinion, instead of using a buy signal with the reverse criteria of a sell signal, a buy should be triggered more easily than a sell.
The EOT (Either of Two) moving average crossover system is designed to address this issue. It uses three moving averages, either simple or exponential. The system triggers a buy when either the short-term moving average is above the medium-term moving average or the medium-term moving average is above the long-term moving average. I like to use the 20, 50, and 200 EMAs with this system instead of the 50-200 EMA crossover method.
The following chart shows both the 20-50-200 EOT crossover system and the 50-200 crossover system applied to the S&P 500.
Click to view larger chart.
Although the performance is essentially the same, when I apply this strategy to the NASDAQ Composite or the Russell 2000, a meaningful difference in performance turns up.
| S&P 500 (starting 10/23/1950) | B&H | 50-200 | 20-50-200 |
|---|---|---|---|
| CAGR | 7.02 | 7.18 | 7.73 |
| SD of rolling annual returns | 14.6 | 10.5 | 11.6 |
| Number of trades | 0 | 54 | 104 |
| Max Drawdown | 56.8 | 33.2 | 33.2 |
| NASDAQ (starting 11/23/1971) | B&H | 50-200 | 20-50-200 |
| CAGR | 8.68 | 8.54 | 10.44 |
| SD of rolling annual returns | 22.8 | 16.8 | 18.4 |
| Number of trades | 0 | 45 | 75 |
| Max Drawdown | 77.9 | 43.5 | 42.8 |
| Russell 2000 (starting 6/23/1988) | B&H | 50-200 | 20-50-200 |
| CAGR | 7.37 | 6.29 | 8.41 |
| SD of rolling annual returns | 17.6 | 11.6 | 13.6 |
| Number of trades | 0 | 32 | 46 |
| Max Drawdown | 59.9 | 27.4 | 30.7 |
What does this tell us?
The EOT trend system’s returns have been higher and more consistent across several indexes than those of the 50-200 crossover strategy. However, its volatility, as well as its number of trades, have also been higher.
A few more thoughts…
This strategy should also perform well when applied to international markets and emerging markets. Emerging markets often snap back fast after a bear market so it makes sense to use the EOT system.
The EOT system can also use weekly 4, 10, and 40 EMAs. It will probably lower performance slightly, but it will take less time to implement.