Some people are unnerved by the stock market’s recent decline. I get it. They’re afraid that the stock market will fall much farther.
Trading and investing is about balancing FOMO (fear of missing out on rallies) and fear of getting caught by crashes.
Most traders are so afraid of getting caught by crashes that they inevitably underperform buy and hold. (I.e. they “predict” 10 of the last 2 crashes).
Here’s a simple and mechanical way to not underperform buy and hold, while also reducing your portfolio’s downside potential.
Only buy when the S&P is above its 200 daily moving average
Simple trend following models do not outperform buy and hold.
- Buying and holding the S&P from 1950 – present yields an average annual return of 7.6%
- Buying and holding the S&P only when it is above its 200 daily moving average yields an average annual return of 7.4%.
However, using this simple trend following strategy is much safer than buy and hold. Your downside is limited because by definition, the major market crashes always happen below the 200 daily moving average.
Here’s the exact same chart, plotted on a log scale.
As you can see, only buying when the market is above its 200 daily moving average is much safer. Less volatility in your returns.
Hence, the easiest way to beat 95% of professional traders is…. (long time readers of the blog can probably guess what it is).
The S&P is right on top of its 200 daily moving average right now.
If you’re risk averse, you can sell if the S&P breaks down. Then if the S&P goes back above its 200 dma (i.e. this isn’t the start of a mega-crash), you can buy back your stocks a little higher then where you sold it. You sacrificed some gains, but in return bought huge downside protection.
This is essentially what Jeremy Grantham advocates.
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