A technical market timing method for Nifty

Technical investor wants to be in sync with the market. Go with the flow is their motto.

On the other hand, fundamental investor wants to zag when the market zigs. Be Fearful when others are greedy and be greedy when others are fearful, says Warren Buffett. Invest when there is blood in the streets, says Sir Templeton.

Who is right? I have a hunch that maybe both are right - at different time scales. Anyhow, in the spirit of this blog, let's test the hunches with the data. Let's see what data has to say.

In this post, i will look at  one of the most common technical method for market timing viz. moving average method. (Fundamental based market timing methods are a topic for another post)

A Moving average is commonly used with time series data to smooth out short-term fluctuations and highlight longer-term trends. Traders most commonly use moving averages of 50-period, 100-period and 200-period.

The strategy is very simple:
i) If today's closing price for Nifty is above N days moving average, then stay in the market.
ii) If today's closing price falls below N days moving average, sell out and stay out of the market till condition i signals you to get back in again.

How did this strategy do in Indian markets over last 10 years? The chart below shows the results of 100 Rupees invested according to 50 day / 100 day and 200 day simple moving average (SMA) strategy. The start date is 1st January 2002 and end date is 31 Dec 2011.

The benchmark is the buy-and-hold strategy i.e. you just invested 100 Rupees in an index fund and stayed invested through thick and thin. This is shown by the third line from the top in the graph.

Click on the graph to see bigger picture.

Both 50 and 100 day SMA strategies did better than buy and hold. They did this primarily by stepping out of the market for a time in 2008. However, the really good part about them is that they allowed one to participate fully during the bull markets. Participate in the upside, minimize damage during downside ... what more can one ask for ;)

Several caveats are in order:
i) Look at 200 day SMA. That strategy didn't work in Indian markets in last 10 years. You left way too much money on the table during bull runs. You were better off just buying and holding through thick and thin.

Note that 200 day strategy is most well known. See Mebane Faber's paper on SSRN where he sings eulogies of 10-month moving average (essentially 200 day). This paper is the 2nd most downloaded paper on SSRN.

With the benefit of hindsight, one can come up with arguments such as 200-day is too slow for today's markets and 50 or 100 days is better. But you didn't know that back then.

ii) Even with a 100 day SMA strategy, there were 6 signals on average per year. That means you had to switch in and out of the markets 6 times a year. Imagine churning your entire portfolio that many times. (There is a workaround which will get you most of the benefits without churning your portfolio - see post on my other blog)

iii) It wasn't very effective in 2011. By the way, i consider that as good news.

So there it is.

As usual, all the nifty index data is from NSE and i have posted the code to github. I have also posted an Excel file so that people who are not familiar with R could replicate my work in Excel and come up with even better timing models.