Strategies that follow crosses of two moving averages have been studied to death, and in their plain vanilla form, they don’t seem to provide much of an edge over a buy and hold approach over the long term. But what they lack in absolute performance they may make up in ease of use.
Until a few months ago, neither a long/short nor a long-only 50/200 simple moving average crossover strategy outperformed the buy & hold approach to the S&P 500. While both crossover strategies are now ahead by virtue of the recent bear market, that’s not in itself a reason to give mechanical strategies like these a second look; what is a reason, however, is the fact that a long-only 50/200 crossover strategy would’ve kept you out of all of the bear markets and the worst trading days over the last 28 years. That includes the dot-com crash, October 1987, and the unwinding of the credit bubble. The graph below shows the daily logarithmic returns of the buy & hold and long-only 50/200 SMA crossover strategies:
Absolute performance is, ultimately, all that matters. But as long as there are human animals choosing strategies and allocating capital, some accommodation must be made for the cognitive biases and innumerable flaws to which we are prone. One way of coping with the fact that any trading system will be subject to what we might simply call “human risk” – the danger that the well-dressed ape sitting behind a desk will break something – is to construct strategies that are less likely to agitate anyone. That means targeting not just absolute returns, but also returns that are less volatile and more consistent. Sharpe, Sortino, and other common metrics do just this: they recognize that a strategy is more valuable if it doesn’t goad the wildlife needlessly.