Moving Averages ... including a Return Moving Average
I was thinking about moving averages and why one would want to compare today's stock price with some n-day moving average which ...
>You mean a simple moving average of daily closing prices?
Well, it could be daily or weekly or whatever ... and it could be a weighted moving average such as
Anyway, it doesn't matter. I just wondered why?
>So you can buy low and sell high, right?
I suppose one needs to ask "low" compared to what, and "high" compared to what?
>Compared to an average price ... over the last umpteen days.
I guess so, but what about looking at a somewhat different moving average price ... like so:
- Each day we calculate the average daily return over the last n days
(instead of the average price).
- We consider a fictitious stock that changes day-to-day according to this average return.
- Then we compare the actual stock price with this fictitious stock price and ...
>A fictitious stock? Can't you invent a neato name, like maybe ...
Let's call it a return Moving Average, or rMA
(to replace the garden variety simple Moving Avaerage: MA).
>rMA? Doesn't that have to do with genetics?
That's rNA and ...
>What's so good about rMA?
I have no idea, but if you believe that stock returns tend to revert to some average return, then when today's return is large compared to that
average return, you might expect tomorrow's return to be smaller and if ...
>Are we talking Reversion to the Mean?
Yeah, I guess so. RTM would suggest that when returns are far from the Mean, they're likely to get closer to the Mean.
>So you want to keep track of the Mean Return, right?
Right. So I made up this spreadsheet which looks like this:
Click on the picture to download the spreadsheet
You enter a stock symbol, click a Download button and get (from Yahoo)
a couple of year's worth of daily prices.
Then you choose two moving averages (say a 100-day and a 5-day
and you get the two regular MA averages and the two rMA averages.
Then you examine the crossovers and decide when to Buy and when to Sell.
>According to which pair of averages?
Your choice ... but the right hand chart gives the Buy / Sell signals using rMA.
>So which is better?
I have no idea, but you can play with the spreadsheet ... just to see what you think of rMA.
You'll notice that, since rMA involves the average return over umpteen days, it gives
a rather slower moving price average.
>I'd call it lethargic.
You'll notice that the red graph, that's rMA, tends to be below the regular, simple MA graph.
>Is that a general rule?
Not if the stock is tanking
Here are more examples:
>Aha! ATYT is going down! Hey! Isn't that your stock?
>So maybe you should look to see when rMA crosses above MA?
I doubt that'd be useful, but play with the spreadsheet ... or, if you like, you can play with this spreadsheet
where you specify the Mean and Standard Deviation and, each time you click a button, a host of returns are selected at random from a Normal distribution.