States the best time period for a moving average of weekly data is 45
weeks, just slightly longer than the 200-day moving average.^10
Testing the Dow Jones Moving-Average Strategy
In order to test the 200-day moving-average strategy, I examined the
daily record of the Dow Jones Industrial Average from 1885 to the pres-
ent. In contrast to the previous studies on moving-average strategies, the
holding-period returns include the reinvestment of dividends when the
strategy suggests investing in the market and interest-bearing securities
when one is not invested in the stock market. Annualized returns are ex-
amined over the entire period as well as the subperiods.
I adopted the following criteria to determine the buy-sell strategy:
Whenever the Dow Jones Industrial Average closed by at least1 percent
above its 200-day moving average, stocks were purchased at these clos-
ing prices. Whenever the Dow Industrials closed by at least1 percent
below its 200-day moving average, stocks were sold. When sold, the
portfolio was invested in Treasury bills and earned interest income.
There are two noteworthy aspects of this strategy. The 1 percent
band around the 200-day moving average is used in order to reduce the
number of times an investor would have to move in and out of the mar-
ket. Without this band, investors using the 200-day moving-average
strategy are often “whipsawed,” a term used to describe the alternate
buying and then selling of stocks in an attempt to beat the market. Such
trades dramatically lower investor returns because of the large transac-
tions costs incurred.
The second aspect of this strategy assumes that an investor buys or
sells stocks at the closing price rather than at any time reached during
the day. Only in recent years has the exact intraday level of the averages
been computed. Using historical data, it is impossible to determine
times when the market average penetrated the 200-day moving average
during the day but closed at levels that did not trigger a signal. By spec-
ifying that the average must close above or below the signal, I present a
theory that could have been implemented in practice.^11
296 PART 4 Stock Fluctuations in the Short Run
(^10) Robert W. Colby and Thomas A. Meyers, The Encyclopedia of Technical Market Indicators, Home-
wood, Ill.: Dow Jones-Irwin, 1988.
(^11) Historically, the daily high and low levels of stock averages were calculated on the basis of the
highest or lowest price of each stock reached at any time during the day. This is called the theoretical
highorlow. The actual highis the highest level reached at any given time by the stocks in the average.