SIP vs. moving average based investing

In today’s article I will evaluate whether we can do better than systematic investment plans (SIP) by using a simple moving average system based on the Nifty.

I read a comment on an article that suggested that individual investors are better served by doing a discretionary investment, plan based on such a rule, as compared to a systematic investment plan. I thought I should check whether this holds or not.

 

What is a systematic investment plan?

An SIP means that an investor invests a constant amount in every investing period, usually a month, irrespective of whether markets go up or down. It enforces investing discipline.

The SIP route has been advocated for a long time and I do not know of any other better way to invest in equity for retail investors who do not have the skills or time to appraise the stock market or individual stocks.

 

What is a discretionary investment plan?

A discretionary investment plan will involve manual timing of investments. It might involve sizing of investments too.

Assuming you have a view that markets will have a relatively large fall, you can hold off investing for a while or reduce investments. This is the first instance where you will have to correctly time a downturn.

If the fall materializes you will have to get the timing right a second time and start buying or increase buying, preferably at the bottom.

 

What are the challenges?

Professional investors cannot get timing right consistently. Decisions by retail investors will typically be less informed than the investors who are doing it full-time. Though, some might even say rightly, that professional investors over-analyze and get it wrong sometimes.

So, if one were to time the market, can there be a system based approach which will be non-discretionary?

This is what I test. I check whether moving averages can be used to time the markets.

 

What are moving averages?

Let us dig in straight into an example.

These are the closing prices of the Nifty over the last 10 days. The third column contains moving averages.

 

DateClose3 day moving average
22-Aug-135408.45
23-Aug-135471.75
26-Aug-135476.505452.23
27-Aug-135287.455411.90
28-Aug-135285.005349.65
29-Aug-135409.055327.17
30-Aug-135471.805388.62
2-Sep-135550.755477.20
3-Sep-135341.455454.67
4-Sep-135448.105446.77

 

Moving average for 4 Sep 2013 is calculated as, 5446.77 = (5448.10+5341.45+5550.75)/3

Moving average for 3 Sep 2013 is calculated as, 5454.67=(5341.45+5550.75+5471.80)/3

The simple moving average for a particular day can be created by taking average of the closing prices of the last three days.

The chart for this relatively small period is shown below.

3 Day moving average of Nifty

What are moving averages assumed to signify?

Technical analysis assumes that when the price of a security or index dips below a moving average, it denotes bearishness and may signal a further fall. The reverse is expected when the price of a security moves above the moving average.

There are more considerations when analysts study moving averages but I will not be getting into many details.

Generally, analysts track the performance of an index versus a 200 day moving average (MA) of the index. When an index moves below the 200 day MA it is considered to be a leading indicator of a bear market. When it moves above the 200 DMA it is assumed that the bear market seems to be over.

These respective outcomes are not 100% guaranteed but are more like thumb rules.

 

How would moving averages be used?

I tested a rule which says that I should invest if the index is above the moving average. If the index goes below the moving average I will cease investing (negative crossover). I will start investing again the day the index moves above the moving average (positive crossover).

You should ask, what happens to the accumulated amount for the days when we have not invested?

I employ a rule where I invest an amount that corresponds to the number of days I have stayed out of the market.

For example, if daily investments are Rs. 300, and if I am out of the market for 10 days, I will invest Rs. 3000 (number of days multiplied by the daily amount) on the day after the positive crossover.

 

Results with a 200 day simple moving average

This is the chart of the Nifty and its 200 day simple moving average over the last thirteen years.

200 day moving average of Nifty

There have been intermittent falls below the 200 day simple MA. There have been two big falls after the one the market got out of by 2002.  One was in 2008 when the global credit crisis hit India. Another was when markets went into a tailspin again in 2011.

I was quite curious about the results as I was doing this exercise. This is what I found.

The daily investment amount was kept at Rs. 300. Rs. 22,29,680 was the money one would have in hand today by investing Rs. 300 everyday from the year 2000 to today.

The manual timing method led to a sum in hand of Rs. 21,57,694. This amount is around Rs. 71,000 less. The SIP method wins comfortably.

 

Results with a 50 day simple moving average

This is the chart of the Nifty and its 50 day simple moving average.

The same pattern was observed. A simple systematic investment plan makes more money than a system with manual intervention based on moving averages.

The daily investment amount was kept at Rs. 300. Rs. 22,16,448 was the money one would have in hand today by investing Rs. 300 everyday from year 2000 to today.

The manual timing method led to a sum in hand of Rs. 21,89,677. This amount is around Rs. 26,000 less.

 

Observations on manual timing

The systematic investment plan works better than manual timing of investments based on moving averages for 50 and 200 day cases.

The reason why manual timing does not work as well is because any moving average has a lagging response to the price of the index. In other words, the index starts rising up well before the moving average does. By the time, it crosses the moving average, one has already missed a rise from the lows. An opportunity to invest at the lowest prices in the trough portions of the chart is missed.

A 50 day MA is more aggressive as compared to a 200 day MA and it still fails to perform better than the 200 day MA.

There are a few points that I should clarify.

  • In practice, an investor who does not have the time to study markets in detail is not going to track the moving average on a daily basis.
  • In practice, a typical SIP investment happens on a monthly basis.
  • If one were to make a check every month, the performance would be more “unscientific” for lack of a better word. The system might have given you a signal and you will possibly take action much later.
  • I suspect results with a monthly check on the moving average will be worse than the results with a daily check on the moving average .

 

Download the Excel for the study of moving average based investing vs. systematic investment plan (SIP).

 

Can this idea be improved?

I am sure it can be improved. To do so, we will need to enter the domain of technical analysis. It is a vast subject in itself and also one that makes people take up sides in the fundamental vs. technical analysis debate.

My personal view is that both have their merits. The bottom line is that as long as you can make money consistently and logically you are fine. You need to be sure that your money-making skills are not a random stroke of luck.

 

Is an improvement worth it for a relatively passive investor ?

No.

If an investor were to go deeper than the study I have taken you through, I think the person would be an “active” investor. This means that they can dedicate more time for decision making.

Remember that we started the discussion saying that this was a investor who executes a systematic investment plan. This would typically mean the multitude of investors in the Indian equity market who do not have the time to dig deeper into equities. They want the benefit of equity returns over the long-term.

I think practically, it is not worth it for a relatively less active investor, if he or she cannot run a simple system that does not consume time. If you feel you cannot dedicate more time than you are already doing and you have an active SIP, you are well-served presently. Do not bother to tinker with it.

What are your thoughts?

Have you tried any investing systems or rule-based mechanisms? What has your experience been? Are there possible improvements to this system?

Use the comments section given below and add to the discussion. Share your views with the Capital Orbit community.

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Comments

  1. Arjun says

    Hi Kunal,

    have you tested this with PE levels as your reference to invest / enter – exit?

    Also, wouldn’t it be more logical to exit your investment when the index falls below the EMA and then re-enter when it crosses above it? My assumption is that this would result in protection of capital which can be used for future investments.

    Finally, a cross over of 2 moving averages may yield better results. But then, you are right, SIP may be the better way for the passive / less active investor.

    • says

      Hi Arjun,

      I have not yet tested with P/E levels. I will check that. It’s pending.

      You are right. One can attempt to make this better with different moving averages and crossovers etc. But then it gets beyond the time and involvement that a relatively passive investor can dedicate to this task.

  2. Anand Agarwal says

    Hi Kunal,

    I know its kind of a late comment on a old blog.

    I recon using a moving average to flip out of accumulated Equity MF SIP into Debt MF and putting it back the grown amount into Equity as it moves above 200DMA.

    While you have flipped out you accumulated amount on the way down you should let the SIP continue.

    This way one will get the power of averaging at the lower prices and will save capital as well.

    I have not back tested it but it should work well.

    regards,
    Anand

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