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The SHOCKINGLY Simple Way Regular Investors (Sometimes) Beat the Market | Next Level Life | YouTubeToText
YouTube Transcript: The SHOCKINGLY Simple Way Regular Investors (Sometimes) Beat the Market
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Core Theme
The moving average method is a technical analysis strategy that uses an investment's past price data to identify trends and generate buy/sell signals, potentially helping regular investors outperform a simple buy-and-hold approach, especially in trending markets.
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there are countless strategies that
investors have come up with over the
years to maximize their returns and
while none of them are foolproof
measures to get the most out of your
money or even beat the overall market
some of them have been surprisingly
successful the majority of the time
today we discuss one such strategy
here's one surprisingly simple way
regular investors can get more out of
their money and possibly beat the market
in the process but before we get going
be sure to like this video if you
haven't already as it really does help
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investing for free today today's
strategy is known as the moving average
method and it comes from the world of
technical investing on the surface it
really is quite simple to understand and
implement but it does have some caveats
that need to be kept in mind if you
decide to try it out for yourself today
we'll discuss how to implement the
strategy as well as some of those
considerations so first things first
what is a moving average a moving
average is simply a way to cut out the
short-term noise produced by an
investment's price fluctuations thus
making it easier to spot trends as you
can see from this chart the price of
this hypothetical investment was pretty
volatile over this 30-day stretch
sometimes rising or falling by 10 or
more but its general trend was upward a
moving average can be calculated in a
few ways the first and simplest method
is by taking the average of an
investment's price over a specific
period of time in this chart i used a
five-day moving average to smooth out
the trend but investors use a wide
variety of durations to calculate their
moving averages depending on their goals
short-term investors may use time frames
of hours or even minutes to get their
averages while longer term investors may
use intervals of several months to a
year or even more to get their averages
anyway technical investors often compare
these moving averages to the current
price of an investment or a second
moving average to determine if they
should sell or buy in this more
simplistic variation we're just looking
to see if the current price of the
investment has recently fallen below the
moving average if it has that tells the
investor that it may be a good time to
cut their losses and sell if the price
should rebound and rise back above the
moving average it's usually seen as a
good time to buy back in according again
to this simplistic variation of the
strategy a second somewhat more complex
way of calculating the moving average is
to use an exponential moving average
this approach is still ultimately trying
to accomplish the same thing as the
simple moving average it's just that
instead of taking a simple arithmetic
average of an investment's price it
weighs recent prices more heavily this
tends to make exponential moving
averages much more responsive to sudden
shifts in price movements which can be a
good or bad thing depending on your
goals and the situation other investors
use multiple moving averages to help
them make investing decisions for
instance you could use a 50 and 200 day
moving average to determine the
investment's trend if the shorter term
moving average in this case the 50-day
average rises above the longer-term
average than you buy if it falls below
the longer-term average then you sell
those are the basics behind the strategy
like i said it's pretty simple you're
just analyzing investments price
movements to determine its trend and
then deciding if that trend is favorable
enough for you to buy the investment or
unfavorable enough for you to cash out
as you can imagine this approach has its
fair share of pros and cons where this
approach really excels relative to your
standard buy and hold strategy anyway is
inconsistently trending markets and as
we'll see with examples here in a minute
it doesn't really matter whether that
trend is positive or negative all that
matters is that it's reasonably
consistent this is because it enables
the moving average investor to avoid the
worst of market crashes while still
participating in the majority of market
run-ups for instance take a look at
these hypothetical returns for an
investment it starts off at 100 a share
but over the next handful of years it
gets hammered losing half of its value
before finally rebounding a buy and hold
investor with 100 put into the markets
would invest their money right away and
just let it sit there regardless of how
the market performs meaning that by the
end of this 10-year period their
investment would be worth around 122
dollars the same as the investment
itself that equates to an average
annualized return of about two percent
per year which is not great on the other
hand a technical investor making their
trades based on indicators like a moving
average may have been able to get out of
the markets before the worst of the
damage occurs and thus achieve a higher
overall return during this time period
as you can see in this hypothetical i've
assumed that our technical investor is
using a simple two-year moving average
under these assumptions they would have
wound up with a net worth of roughly 146
dollars in this admittedly very
oversimplified hypothetical that equates
to an average annual return of about 3.9
percent per year still not great but at
the same time it's nearly double what
the buy and hold investor achieved
during this decade where moving average
approaches can struggle is when the
markets experience a lot of volatility
and as a result don't really produce a
consistent trend in one direction or
another this is mainly because these
choppier markets can create a lot of buy
and sell signals in a relatively short
period of time which can lead to higher
trading costs and possible undesirable
tax consequences in addition to possibly
missing out on sudden and big market
reversals kind of like what happened
between years five and six in that
hypothetical the markets experienced a
sudden reversal after bottoming out in
year five and rose by a whopping 50
percent but because the moving average
hadn't had enough time to adjust to that
new reality our technical investor
missed out on that year's gains and as
we've seen in previous videos on this
channel it's not uncommon for markets to
bounce back in a big way in the first
year or so of a market rally for a great
real world example of a time period in
which the markets were generally
trending upward in a way that produced
superior returns from moving average
investors we need look no further than
the most recent decade of the 2010s the
markets peaked in october 2007 before
beginning a precipitous drop during the
great recession that would see them
bottoming out roughly 50 below their
previous highs in march 2009 from there
they would more or less be on the rise
for the next decade until this most
recent downturn in early 2020 got
started during the near 11-year time
period between the bottom of the great
recession and the peak in early 2020 if
you had simply invested ten thousand
dollars into an s p 500 index fund and
held it there that investment would be
worth roughly 50 000
if you had used a simple 50-day moving
average to determine whether you should
be buying or selling your net worth
would be around sixty thousand seven
hundred dollars by the time the market
peaked in twenty twenty that's an
average annualized return of about
fifteen point nine percent per year for
the buy and hold investor before
dividends are reinvested and about
eighteen percent per year again before
dividends for the simple moving average
method for a great example of a time
period when the stock market was
crashing and burning we can look to the
stock market crash during the great
depression in the early 1930s the
markets had recently experienced a crazy
run-up during much of the 1920s with for
the last five years of the decade even
posting price returns meaning without
dividends of 19 or more but in september
and october of 1929 the markets started
showing signs of turbulence which would
turn into the worst crash in the history
of the us stock market when the dust
finally cleared in june 1932 the markets
had lost nearly 90 percent of their
value buy and hold investors naturally
fared horribly during these years with a
hypothetical 10 000 investment falling
to less than 1400 by the summer of 1932.
that's the equivalent to an average
annualized return of negative 52.4 per
year however amazingly technical traders
using a simple 50-day moving average
would have actually made money in the
stock market during this period a ten
thousand dollar investment for our
hypothetical moving average investor
would have grown to be worth just over
eleven thousand nine hundred dollars
that's the equivalent to a six point
eight percent per year annualized return
and given the market environment we're
talking about here that's enormously
impressive of course not all markets are
as great for investors as the bull
market of the 2010s just as not all
markets are as difficult for investors
as those of the early 1930s and as i
said earlier one of the things that need
to be remembered about using moving
averages is that they tend to work best
in consistently trending market
environments again it doesn't really
matter whether the markets are
consistently trending upward or
consistently trending downward just so
long as they are fairly consistently
trending in whichever direction they're
trending in but not all market
environments are so consistent take last
year for instance 2020 was pretty
volatile and as a result may have
resulted in a few buy or sell signals
for those keeping an eye on those moving
averages from march 23rd 2020 to the
same time next year a 10 000 investment
in the s p 500 would have grown to
around seventeen thousand five hundred
dollars that same ten thousand dollars
under a fifty day moving average method
would have only grown to around thirteen
thousand five hundred dollars with that
being said there are definitely some
caveats or at least considerations that
we do want to keep in mind when it comes
to using indicators like moving averages
to help us make our investing decisions
one as i already mentioned is that this
more active style of trading can
sometimes lead to higher costs namely in
the form of trading costs and or some
potentially serious tax consequences
depending on your situation in some
cases the difference in the costs
incurred by a more active technical
investor and a buy and hold investor can
be significant enough to make up for
most or even all of the additional
pre-tax pre-cost gains that the moving
average approach earned the technical
investor for instance in the post-grade
recession example that we explored a
minute ago we saw that the active
investor using a simple 50-day moving
average ended up with roughly a 20 edge
in terms of net worth over a buy and
hold investor before things like taxes
and trading costs were taken into
account unfortunately for the active
investor literally all of their gains
during these years would have been taxed
as short-term capital gains at their
ordinary income tax rate this is because
there wasn't a single instance of them
buying into the market and holding that
investment for at least a year and a day
in fact it was rare for them to go more
than a few months without cashing out
which means that if the investor was in
the 22 federal tax bracket which is not
all that unlikely given that they were
realizing several thousand dollars worth
of capital gains virtually every year
and that 22 tax bracket starts out at
around 40 000 a year for singles as of
2022 literally their entire edge would
have been wiped out by federal income
taxes alone it would have been even
worse if they'd lived in a state that
also taxed their gains so that's
definitely something worth taking into
consideration if you're looking at
trading actively in this manner and are
investing in a taxable account now you
might be thinking well dan that's
irrelevant because i can just use longer
moving averages so that i'm not
realizing those short-term capital gains
and on the surface that seems like an
obvious and simple solution to the
problem but there may be a catch the
catch is not all look back periods or
the amount of time you use to calculate
your moving averages will be as
successful as others in any given market
environment as we saw in the great
recession example using a shorter 50-day
look-back period we managed to produce
superior returns compared to a buy and
hold investor on a pre-tax pre-cost
basis however a longer look-back period
say 200 days since that's a pretty
common one to use wouldn't have been
nearly as successful if we had used a
200-day moving average to make our
trading decisions during the great bold
run of the 2010s our ending net worth
would have come out to around thirty six
thousand seven hundred dollars or a good
thirteen thousand dollars short of the
buy and hold approach before taxes and
costs are factored in a 250-day
look-back period which is roughly
equivalent to a year because the markets
aren't open on weekends and holidays
would have produced similar results with
a 36 400 ending net worth so yeah
different market environments will lead
to different advantages or disadvantages
for different look-back periods shorter
look-back periods or using an
exponential moving average instead of a
simple moving average tend to do better
in markets where the trends are sharper
since it can react quicker to those
changes but market environments that are
more of a slow burn can favor longer
back periods a bit more than their
shorter counterparts and without having
a crystal ball it's darn near impossible
to tell ahead of time which variation
will outperform and that's not to
mention that the longer your look back
period is the more likely it is that
you'll start missing out on dividends
from your investments which can give the
buy and hold approach a little bit of an
extra edge so there you have it that's
one relatively simple way that regular
investors can sometimes beat the market
it's not a foolproof strategy to beat
the market i mean as far as i'm aware
such a strategy doesn't actually exist
but because the markets tend to rise
more often than they fall and because
human psychology and emotion tends to
lead to markets building and sustaining
momentum better than a random chance
would suggest it should it is an
approach that can be surprisingly
effective in a lot of situations at
least as long as you figure out a way to
manage the potential costs associated
with those more frequent trades such as
utilizing tax advantaged accounts to
minimize your income tax burden and that
you're willing and able to stick to the
strategy over the longer haul without
shooting yourself in the foot but what
do you think have you ever used moving
averages to help make investment
decisions what other metrics do you take
into consideration when investing let me
know in the comments section below but
that'll do it for me today once again if
you enjoyed this video be sure to smash
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