Examining the predictive power of moving averages in the stock market

Abstract

Moving averages are common technical analysis tools which investors use to generate buy and sell calls in the stock market. The purpose of this research paper is to analyse whether common moving average techniques can reliably predict stock market behaviour. Using hypothesis testing, this paper tests whether the percentage return yielded by using moving average combinations to trade stocks in the S&P 500 index was significantly higher than a) the percentage return yielded by randomly buying and selling the stocks and b) the market percentage return. The tests were conducted for the S&P 500 stocks in four different time frames to understand the performance of moving averages during different stock market trends (uptrend, sideways trend, downtrend). Moreover, the performance of three different buying and selling techniques which use moving averages were compared. The results of the paper indicate that an investor should not use moving averages to trade stocks owing to their limited predictive power. There were only a few moving average combinations which were significantly better than randomly buying and selling. Even those few combinations could not yield higher percentage returns than the market percentage return.