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WALL STREET, CALIFORNIA | STREET STRATEGIES / JON D.
MARKMAN

A Coupla 'Average' Guys : Moving Averages Get Heavy Consideration in Trading Decisions

December 10, 1996|JON D. MARKMAN

If I knew you ate granola and bananas for breakfast every day for the last nine months, it's not much of a stretch to predict that you'll eat either granola or bananas tomorrow.

In a nutshell, that's the reasoning behind a remarkably successful set of techniques that relies almost exclusively on the moving average of share prices to decide when to buy and sell stocks. The theory is that although the recent past may not perfectly foreshadow the future, it certainly offers powerful clues.

Moving averages of major market indexes point straight up toward 1997, despite the terrific run in prices over the last six years, according to two of the nation's most prominent advocates of moving-average systems: Nelson Freeburg Jr. and Doug Fabian.

Their systems are not too complicated but do require mastery of a pencil and calculator, or, better yet, a computer spreadsheet program. Also, you've got to accept the unpopular view that it is possible to time the market successfully.

First, note that a moving average provides a snapshot of where a stock price or market index is now relative to its recent trend. To calculate a typical short-term moving average for the last 15 days, simply add up a stock or market index's closing prices over the previous 15 market days and divide by 15. For a more intermediate nine-month picture, add the closing prices of the last 39 weeks and divide by 39.

Many investment sites on the Internet's World Wide Web, such as PC Quote (http://www.pcquote.com), Microsoft Investor (http://investor.msn.com) and DBC Online (http://www.dbc.com), offer moving-average charts for free or a minimal charge.

Freeburg, publisher of the Formula Research newsletter in Memphis, Tenn. ($195 per year, [800] 720-1080), has developed trading systems based on moving averages over the last 20 years and garnered top-drawer clients such as money manager Martin Zweig and Goldman Sachs' research department.

Freeburg believes 70% of a stock's movement can be explained by trends in the overall market, not the company's fundamentals. As proof, he notes that in every major correction, including the one in July, high-quality stocks such as Intel, GE and Microsoft are beaten up without regard to their superior qualities.

However, he thinks that moving averages by themselves mean little unless used with other indicators, mainly changes in interest rates.

Freeburg calls one of his best and most simple methods PAL, after rules governing the launch of nuclear missiles from U.S. submarines. Like the Navy's Permissive Action Link protocol, which keeps warheads in their bays until a series of authorizations are given for release, PAL investors leave 100% of their money in the market until specific signals arise.

Under the rules of engagement, a PAL investor buys a mutual fund mimicking the large-capitalization stocks in the Standard & Poor's 500 index, such as Vanguard Index Trust 500 or Rydex Nova, and holds until the S&P 500 index falls below its 42-week moving average and either the yield on the 30-year Treasury bond rises above its 42-week moving average or the yield on 90-day Treasury bills moves above its 10-week moving average.

When a sell signal is generated, conservative money is switched out of stocks and parked in a money market account; aggressive money is placed in the Rydex Ursa fund, which shorts S&P 500 futures contracts (i.e., a bet on a falling market). Generally, such strategies shouldn't be used with funds of companies, like Fidelity, that charge investors who switch in and out of a fund more than four times a year.

If you had stumbled upon the PAL system on Jan. 8, 1954, and laid down $10,000, Freeburg says, you would have $5.2 million (at least, before taxes or trading fees) in your account today--an average annualized return of 15.7%. Simply buying and holding the S&P 500 for the same period, he said, would have put just $1.5 million in your account--an annual return of 12.3%.

The model's last signal was a buy, issued on Dec. 16, 1994, so PAL followers have been fully invested since then. Money invested then had grown 72.8% through November.

The strategy works, Freeburg says, because the bond market is the most reliable leading indicator of the stock market. When interest rates fall, stocks become more appealing to investors; conversely, a rise in rates makes stocks less appealing.

Sound too complicated?

Then check out a simpler but similar market-timing strategy described every two weeks in a newsletter published by Fabian Premium Investment Resources in Huntington Beach ($179 per year; [714] 536-2201; http://www.fabian.com).

Doug Fabian has built a following of 30,000 readers with a method that has wrung a 15.8% annual compounded return from the market since 1977. It's best followed in the well-designed letter, but it can be done with a spreadsheet, too.

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