• Print
  • Default text size A
  • Larger text size A
  • Largest text size A

What breaking the 50-day average really means

The stock market is now below its 50-day average. Now what?

  • By Mark Hulbert,
  • MarketWatch
  • – 01/28/2014
  • Facebook.
  • Twitter.
  • LinkedIn.
  • Google Plus
Please enter a valid e-mail address
Please enter a valid e-mail address
Important legal information about the e-mail you will be sending. By using this service, you agree to input your real e-mail address and only send it to people you know. It is a violation of law in some jurisdictions to falsely identify yourself in an e-mail. All information you provide will be used by Fidelity solely for the purpose of sending the e-mail on your behalf.The subject line of the e-mail you send will be "Fidelity.com: "

Your e-mail has been sent.

Does the market's break late last week below its 50-day moving average mean that the intermediate trend is now down?

Many technically oriented investors think it does, which is no doubt one reason why the market plunged last Friday.

But I am not so sure that breaking the 50-day moving average has the significance that technicians are giving to it. In fact, a careful analysis of the stock market in recent decades does not find that the market performed appreciably better when it was above the 50-day moving average than when below.

Take the period since early 2000, right at the top of the Internet bubble. We've had two severe bear markets since then, of course, which means that the intervening period is precisely the kind in which a market-timing system like the 50-day moving average should be able to show its stuff.

And, yet, it hasn't added value since then.

Consider a hypothetical portfolio that switched between a total-stock-market index fund and 90-day Treasury bills whenever the S&P 500 index (.SPX) crossed above or below its 50-day moving average. Since the beginning of 2000, this hypothetical portfolio produced an annualized return that was 0.2 of a percentage point below a simple buy-and-hold strategy. Note that these returns take into account the dividends the portfolio would earn while invested in the stock market and the interest earned by the T-bills when the portfolio was out of the market.

Crucially, however, these returns do not take transaction costs into account. If I had included them in my calculations, then the moving-average portfolio would have lagged a buy-and-hold by even more. In other words, even without transaction costs, this 50-day moving average portfolio lagged the market since 2000.

To be sure, the 50-day moving average hasn't always been this poor of a market-timing indicator. But you have to go back several decades before you find a period in which it beat a buy-and-hold strategy. In the decade of the 1990s, for example, the 50-day moving average strategy lagged a buy-and-hold strategy by an even greater margin.

Blake LeBaron, a finance professor at Brandeis University who has extensively analyzed various technical-analysis strategies including moving averages, says that it appears as though, around 1990, something changed in the financial markets that largely eliminated the moving average's potential as a market-timing indicator.

What might that something be? Prof. LeBaron speculates that one culprit might be the moving averages increasing popularity, coupled with the greater ease with which investors could follow them — due to lower commissions and increasingly sophisticated trading technologies. As more and more investors begin to follow a system, of course, its potential to beat the market begins to evaporate.

In any case, Prof. LeBaron noted, moving-average systems stopped being profitable in the foreign-exchange markets at about the same time that they lost their effectiveness in timing the U.S. equity market. This increases the likelihood that whatever caused the moving average to become less profitable in the stock market was more than just a fluke.

Of course, it's always possible that the stock market is, in fact, now in the early stages of a correction, or something even worse. My point is it's premature to conclude that it is, simply because the market has now broken below its 50-day moving average.

  • Facebook.
  • Twitter.
  • LinkedIn.
  • Google Plus
Please enter a valid e-mail address
Please enter a valid e-mail address
Important legal information about the e-mail you will be sending. By using this service, you agree to input your real e-mail address and only send it to people you know. It is a violation of law in some jurisdictions to falsely identify yourself in an e-mail. All information you provide will be used by Fidelity solely for the purpose of sending the e-mail on your behalf.The subject line of the e-mail you send will be "Fidelity.com: "

Your e-mail has been sent.
Copyright © 2014 Dow Jones & Company, Inc. All Rights Reserved.
Votes are submitted voluntarily by individuals and reflect their own opinion of the article's helpfulness. A percentage value for helpfulness will display once a sufficient number of votes have been submitted.

Links provided by Fidelity Brokerage Services

fidelity-fbs-iconThese links are provided by Fidelity Brokerage Services LLC ("FBS") for educational and informational purposes only. FBS is responsible for the information contained in the links. FICS and FBS are seperate but affiliated companies and FICS is not involved in the preparation or selection of these links, nor does it explicitly or implicitly endorse or approve information contained in the links.

Published by Fidelity Interactive Content Services

Content for this page, unless otherwise indicated with a Fidelity pyramid logo, is published or selected by Fidelity Interactive Content Services LLC ("FICS"), a Fidelity company with main offices in New York, New York. All Web pages that are published by FICS will contain this legend. FICS was established to present users with objective news, information, data and guidance on personal finance topics drawn from a diverse collection of sources including affiliated and non-affiliated financial services publications and FICS-created content. Content selected and published by FICS drawn from affiliated Fidelity companies is labeled as such. FICS selected content is not intended to provide tax, legal, insurance or investment advice and should not be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security by any Fidelity entity or any third-party. Quotes are delayed unless otherwise noted. FICS is owned by FMR LLC and is an affiliate of Fidelity Brokerage Services LLC. Terms of use for Third-Party Content and Research.
Content for this page, unless otherwise indicated with a Fidelity pyramid logo, is published or selected by Fidelity Interactive Content Services LLC ("FICS"), a Fidelity company with main offices in New York, New York. All Web pages that are published by FICS will contain this legend. FICS was established to present users with objective news, information, data and guidance on personal finance topics drawn from a diverse collection of sources including affiliated and non-affiliated financial services publications and FICS-created content. Content selected and published by FICS drawn from affiliated Fidelity companies is labeled as such. FICS selected content is not intended to provide tax, legal, insurance or investment advice and should not be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security by any Fidelity entity or any third-party. Quotes are delayed unless otherwise noted. FICS is owned by FMR LLC and is an affiliate of Fidelity Brokerage Services LLC. Terms of use for Third-Party Content and Research.
fidelity-fbs-iconThese links are provided by Fidelity Brokerage Services LLC ("FBS") for educational and informational purposes only. FBS is responsible for the information contained in the links. FICS and FBS are seperate but affiliated companies and FICS is not involved in the preparation or selection of these links, nor does it explicitly or implicitly endorse or approve information contained in the links.

Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information.  Read it carefully.