V-shape equity recovery: a killer for momentum crossover strategies

Even though the financial markets recently experienced a variety of interesting events, the most surprising one was the fast recovery in equities since they hit their low on March 23rd. Figure 1 shows that the SP500 has pulled back to its 50% Fibo retracement of its yearly high-low range, experiencing one of its fastest rally after plunging by 35%. In addition, we saw that one popular technical indicator, the 50D-200D simple moving average crossover, has been forming a ‘death cross’ in the past, which traditionally indicates a bearish signal to market.

Figure 1

SP500

Source: Eikon Reuters

There are many popular momentum strategies based on MA crossovers (both simple and exponential), but the death cross vs. golden cross is a very known one for all asset classes and is closely followed by many market participants. It is a simple systematic strategy, that sends a positive signal when the short-term moving average (50D) trades above the LT MA (200D), which is also called a ‘Golden Cross Formation’, and sends a bearish when the ST MA trades below the LT MA (‘Death Cross Formation’).

Looking at 25 years of daily data, we compute the performance of the Long/Short strategy on the SP500 and compare it to the performance of the SP500 index. Figure 2 shows that the 50/200 crossover strategy generally performs well in periods of slowly trending market (either bull or bear markets), but experiences severe drawdowns in periods of choppy markets. Figure 2 also compares the performance of the L/S strategy with the buy-and-hold one. For a similar volatility, the L/S strategy enhances our annual return by 1.4% to 8.5% for a Shape ratio of 0.44 (vs. 0.37). In addition, drawdowns are significantly reduced as investors are shorting the SP500 in periods of bear equity markets.

Figure 2

Crossover

Source: Eikon Reuters, RR calculations

Based on these results, it seems very tempting for buy-and-hold investors to change their strategy to the systematic one and therefore avoid severe losses in periods of selloff. However, we think that equities will experience frequent V-shape forms with central banks trying to prevent the stock market from falling by 50%+ in the future, which will be devastating for momentum strategies such as MA crossovers. In other words, it will be the death of the ‘Death Cross’ crossover strategy.

 

FX Technical Analysis

This page aims to provide the major technical indicators used in Finance, and especially in the Foreign Exchange market. In addition to define the several steps to compute each specific indicator, we describe a potential systematic (and tactical) strategy applied to currencies and also provide an Excel File (with VBA macros). Hence, readers are able to see how those technical indicators are built, and then can backtest a few strategies on exchange rates using their own parameters.

We chose to first start with the major indicators used by market participants: there are the Moving Average (Simple and Exponential), the Relative Strength Index (RSI), the Moving Average Convergence Divergence (MACD) and the Bollinger Bands.

  1. Link to Momentum Indicators ===> TA_Momentum
  2. Link to Reversal Indicators ===> TA_Reversals
  3. Link to Excel File ===> TechnicalAnalysis_Indicators

Figure 1. Performance of a L/S Portfolio using EMA(5,20) on USD/AUD

Performance.PNG