Stocks & Commodities V. 10:8 (332-335): Moving Average Crossovers by Arthur A.

Merrill, CMT

Moving Average Crossovers

by Arthur A. Merrill, CMT

Are moving average crossovers more effective than other indicators? More specifically, how about
moving average crossovers applied to the Dow Jones Industrial Average? S&C contributor Arthur
Merrill decided to research the question using weekly data for the last 24 years, checking out crossovers
with a four-week exponential moving average and with 13-, 26- and 52-week exponential averages. Here
are his results.

O ne of the earliest technical tools, as easy to figure with pens and paper as well as with computer later
on, was a price chart and a moving average with a simple set of instructions: When the red line crosses
over the blue line, buy!
I have wondered just how good the Dow Jones Industrial Average (D JIA) crossovers were in forecasting
the future of the DJIA itself. When the DJIA is above its 26-week average, what are the prospects for the
future? Would it be better to watch the four-week average compared with the 26-week? How about the
other possible crossovers?
Intrigued, I decided to put the question to my computer, and the results are in Figures 2 through 6. I
wanted to look at the weekly data bank for the last 24 years, and I decided to divide the 24-year period
into two 12-year tests. The first would cover 1968 through 1979. The results for this period are the
left-hand bar in each pair. The second period covered the years from 1980 through 1991. These results
are reported in the right-hand bar of each pair.

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Stocks & Commodities V. 10:8 (332-335): Moving Average Crossovers by Arthur A. Merrill, CMT

FIGURE 1

FIGURE 2: The percent of the weeks that were successful are charted in Figures 2 through 6 Here,
when the DJIA was above its four-week average, it was successful in calling the direction of the market
in the following week only 51.5% of the time in the first test period and 50.6% of the time in the second,
almost even money.
Stocks & Commodities V. 10:8 (332-335): Moving Average Crossovers by Arthur A. Merrill, CMT

FIGURE 3: Here, the results in forecasting five weeks ahead were better but still not enthusiastic. The
best score was C/52 (highly significant, 57.5%).
Stocks & Commodities V. 10:8 (332-335): Moving Average Crossovers by Arthur A. Merrill, CMT

FIGURE 4: Here, the crossovers put in the best performance of all the time periods. Two of the
crossovers were more than 60% (4/52: 61.5% and 13/26: 62.3%). The odds here are six to four.
Several of the reports were highly significant, but below the 60% level .
Stocks & Commodities V. 10:8 (332-335): Moving Average Crossovers by Arthur A. Merrill, CMT

FIGURE 5: Several crossovers were highly significant but slightly below the 60% level The best were
C/26 (59.0%), C/52 (59.2%) and 13/26 (59.0%). Close behind were 4/13 (58.0%), 4/52 (58.3%) and
26/52 (58.2%).
Stocks & Commodities V. 10:8 (332-335): Moving Average Crossovers by Arthur A. Merrill, CMT

FIGURE 6: The forecasts one year ahead lean toward the negative, forecasting a change in trend. The
longest-term averages gave highly significant forecasts in the first 12-year period(13/52:42.8% and
26/52:42.5%). For a continuation of the trend in the same direction, the very short term (C/4: 56.7%)
reported the best performance .
Stocks & Commodities V. 10:8 (332-335): Moving Average Crossovers by Arthur A. Merrill, CMT

I asked the computer to check out crossovers of the current price with the four-week, the 13-week, the
26-week and the 52-week exponential moving averages. (See sidebar, "Exponential moving averages.")
These are marked as C/4, C/13, C/26 and C/52 on the figures. I then asked the computer to check out
other possibilities. For example, 13/26 checks the 13-week compared with the 26-week average.
Note that the test includes all weeks in the test period, not just the week of the actual crossover. The
entire period after a bullish crossover was considered bullish until a bearish crossover occurred, when the
stance was changed to bearish. With this interpretation, we get enough data points to check significance.

YES OR NO?
Then I asked the computer to look into the future one week. Was the D JIA higher or lower? The results
can be seen in Figure 2. What about four weeks later (Figure 3)? What about 13 weeks (Figure 4)? What
about 26 weeks (Figure 5)? Or even 52 weeks (Figure 6)?
The computer looked at each week in the test periods. If the short-term average was higher than the
longer-term average and the DJIA was higher at the later date, the call was rated successful. If the DJIA
was lower, it was called unsuccessful. In addition, if the short-term average was below the longer term
and the DJIA was lower at the later date, the call was rated successful. If the DJIA was higher, it was rated
unsuccessful. The percent of the weeks that were successful are charted in the bars in Figures 2 through 6.

When the DJIA is above its 26-week average, what are the
prospects for the future? Is it better to watch the four-week
average compared with the 26-week?
For example, look at the first pair of bars in the upper left-hand corner of Figure 2. When the DJIA was
above its four-week average, it was successful in calling the direction of the market in the following week
only 51.5% of the time in the first test period, and 50.6% of the time in the second. This is almost even
money, and it certainly was no help!
The next job assigned to the computer was a check of significance. Did the results differ significantly
from pure chance? To find out, I used the chi-squared test. If the result could have occurred by chance
once in 20 repetitions of the test, the result was referred to as probably significant (PS). If the result could
have occurred by chance once in 100 repetitions, it was referred to as being significant (S). If the result
could have occurred once in 1,000 times, it was considered to be highly significant (HS).
After inspecting the charts, the first impression garnered is the poor record reported for the first 12 years
(the left-hand bar of each pair). The only significant deviation from chance is in Figure 6, when the
forecasts were significantly incorrect. This isn't necessarily bad; the incorrect forecasts merely signaled a
reversal of trend at the later date. However, the difference in the two 12-year periods isn't reassuring.
Some indicators decline in effectiveness through the years; perhaps these moving average relationships
have improved their effectiveness in recent years. The second 12 years certainly reported some
significantly successful results.

LESS THAN ENTHUSIASTIC?

For the test results, consider Figure 2. The success in calling the DJIA one week ahead is certainly far

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Stocks & Commodities V. 10:8 (332-335): Moving Average Crossovers by Arthur A. Merrill, CMT

from enthusiastic. The three best were C/52 (56.4%), 4/52 (55.6%) and 13/26 (55.5%).
In Figure 3, the results in forecasting five weeks ahead were better but still not enthusiastic. The best
score was C/52 (highly significant, 57.5%).
In Figure 4, the crossovers put in the best performance of all the time periods. Two of the crossovers
were more than 60% (4/52: 61.5% and 13/26: 62.3%). The odds here are six to four. Several of the
reports were highly significant, but below the 60% level.
Figure 5 shows the success in calling the DJIA in the following six months. Several of the crossovers were
highly significant but slightly below the 60% level. The best were C/26 (59.0%), C/52 (59.2%) and 13/26
(59.0%). Close behind were 4/13 (58.0%),4/52 (58.3%) and 26/ 52 (58.2%).
The forecasts one year ahead (Figure 6) lean toward the negative, forecasting a change in trend. The
longest-term averages gave highly significant forecasts in the first 12-year period (13/52: 42.8% and
26/52: 42.5%). For a continuation of the trend in the same direction, the very short term (C/4: 56.7%)
reported the best performance.

THE MOST USEFUL

Overall, which averages were the most useful? If we skip the one-year forecast and consider the average
performance in forecasting one week, five weeks,13 and 26 weeks ahead, the best average score was
reported by the longer-term 13/26.
The conclusions I determined from this study were:
1) The relative position of moving averages can give significant opinions of the future.
2) The odds for success aren't high;
they rarely exceed six to four.
3) The results reported by the first 12-year period don't confirm the second.
My overall conclusion? I'll watch these moving average relationships but I won't give them too much
weight, because of conclusions 2 and 3.
Arthur Merrill of Merrill Analysis, Inc., Elm #3325, 3300 Darby Rd., Haverford, PA 19041, is a
Chartered Market Technician and the author of many reports and books, including Behavior of Prices on
Wall Street and Filtered Waves, Basic Theory.

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Stocks & Commodities V. 10:8 (332-335): SIDEBAR: EXPONENTIAL MOVING AVERAGES

EXPONENTIAL MOVING AVERAGES

Defining exponentially smoothed moving averages — which, for most traders, would be a series of
closing prices — is simply another form of a moving average. An exponentially smoothed moving
average utilizes a smoothing constant (α) that approximates the number of days for a simple moving
average. This constant is multiplied times the difference between today's closing price and yesterday's
moving average value. This new value is then added to yesterday's moving average value (Figure 1):

(
EMA today = EMA yesterday + α Ptoday - EMA yesterday )
The actual formula that is mathematically reduced for a geometrically (exponentially) weighted moving
average is:
Exponential Moving Average—The EMA for day D is calculated as: EMAD = αPRD + (1-α)EMAD-1
where PR is the price on day D and α (alpha) is a smoothing constant (0-1). Alpha may be estimated
as 2/(n+1), where n is the simple moving average length.
The α constant approximates for a simple moving average. Its value is determined by the formula 2/(n +
1) where n is the number of days for a simple moving average. An approximation for a 10-day moving
average would use an α = 2/(10+1) = 0.18.

—Editor

REFERENCES
Granger, C.W.J., and Paul Newbold [1986]. Forecasting Economic Time Series , second edition,
Academic Press, Inc.
Hutson, Jack K. [1984]. "Filter price data: moving averages vs. exponential moving averages," Technical
Analysis of STOCKS & COMMODITIES, Volume 2: May/ June.

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Stocks & Commodities V. 10:8 (332-335): SIDEBAR: EXPONENTIAL MOVING AVERAGES

SIDEBAR FIGURE 1

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