Bull Market Signal Strategy – Predicting Bull Markets with Backtest

Usually, timing strategies generate a lot of false signals that cause traders to lose money. To avoid that, today we will look at a strategy that does not generate false signals and can successfully predict the end of a bear market: A bull market signal.

The bull signal is the following: 18 consecutive closes above the 200 SMA in a bear market. After the bull market signal, the forward returns tend to be pretty strong. The market is up 21.84% on average one year after the signal is triggered.

Today we will create a timing system for the stock market, backtest a bull signal strategy, and compare it against other timing systems.

Bull market signal: 18 consecutive closes above the 200 SMA in a bear market – trading rules

Because the signal only tells us when to buy we are going to create a timing model to backtest it.

The strategy will sell the S&P 500 when it drops 20% from its all-time high and trigger a buy signal when the S&P 500 closes 18 consecutive days above its 200-day moving average.

Having this in mind, the trading rules are pretty simple:

Trading Rules

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Bull market signal strategy – backtest

We backtested the strategy on the S&P 500 index from 1927 till today. In that timeframe, it generated 12 trading signals, as there have been only 12 bear markets. Also, keep in mind we didn’t use data adjusted for dividends or splits in our backtest.

Here is the equity curve:

The strategy metrics and statistics can be broken down into the following numbers:

• CAGR is 7.24% (5.83% buy and hold) (not including dividends reinvested)
• The standard deviation is 15.26 (18.96)
• Sharpe ratio 0.24 (0.15)
• Time spent in the market is 87.38%
• Risk-adjusted return is 8.28% (CAGR divided by time spent in the market)
• Max drawdown is 60% (86.2%)

The bull signal strategy performs well: It increases the CAGR while reducing volatility and time spent in the market. 

The maximum drawdown may seem high, but that was because of the crash of 1929. If we exclude that bear market, the strategy maximum drawdown drops to around 25% – just half of buy and hold. 

After the buy bull signal is triggered, the S&P 500 is up on average 9.54% six months after and 21.84% one year after. 

Comparing the strategy versus other timing systems

How does this strategy stand among other timing models? We compare it to one of the most known patterns in trading: The golden cross.

The golden cross strategy generates two signals: a sell signal when the 50-day moving average crosses under the 200-day moving average, and a buy signal when the 50-day moving average crosses above the 200-day moving average.

How has this strategy performed since 1927? Here is the equity curve and some stats and metrics comparing it against our timing model:

• CAGR is 6.06% (7.24%)
• The standard deviation is 13.26 (15.26)
• Maximum drawdown is 33.9% (60%)
• Time spent in the market is 66.5% (87.38%)
• Risk-adjusted return is 9.11% (8.28%)

As you can see, our bullish signal performs better (although not on a risk-adjusted basis), and it’s invested in the market 30% more time than the Golden Cross.

The advantage of our system is that it does not generate false signals. The Golden Cross has generated 49 signals since 1927, while our model generated only 12.

Bull market signal strategy  – conclusion

To sum up, 18 consecutive closes above the 200 SMA in a bear market is a strong bull market signal after a bear market. The S&P 500 is up 100% of the time, 12 months after the signal is triggered. 

The last time this signal was triggered was the 15 of February of 2023. This raises the question, is the 2022 bear market over?

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FAQ:

What is the significance of 18 consecutive closes above the 200 SMA in a bear market?

This pattern serves as a powerful bull market signal. It occurs when the S&P 500 closes above its 200-day Simple Moving Average (SMA) for 18 consecutive days during a bear market. Historically, this signal has been associated with the end of bear markets and strong forward returns.

How does the bull market signal strategy work, and what are its trading rules?

The strategy involves selling the S&P 500 when it drops 20% from its all-time high, and buying when it closes above its 200-day SMA for 18 consecutive days. The key trading rules include initiating a buy signal in a bear market and holding until the next bear market.

What are the metrics and statistics of the bull market signal strategy’s backtest?

The backtest of the strategy from 1927 to the present generated a CAGR of 7.24%, a standard deviation of 15.26, a Sharpe ratio of 0.24, and a maximum drawdown of 60%. The time spent in the market was 87.38%, providing a risk-adjusted return of 8.28%.