Shorting Growth Stocks - Backtesting a Moving Average Strategy on ARKK
If you’re on Financial Twitter, known as “Fintwit”, then you’ve probably heard of Puru Saxena. He is one of the more popular Fintwit personalities, with about 250k followers.
He’s popular because he is a former money manager and he knows what he’s talking about.
Anyways, he normally likes to invest in growth stocks, but lately, he hasn’t been so bullish on these kinds of stocks due to various factors.
From what we know, Puru has mentioned that he hedges his long exposure by shorting the ARKK ETF. And part of his strategy involves shorting when the 5-day exponential moving average (EMA) crosses under the 7 day EMA.
His strategy involves more things and we are not FULLY sure what the strategy is, so this is not going to be a replica of his strategy. So keep this in mind, this is not Puru’s strategy. This just made us curious about the 5 and 7 EMA vs. ARKK, which is why we are backtesting it, using his ideas as inspiration.
Using TrendSpider’s backtesting tools, let’s see how that works.
We’ll test out a few variations of this, so stick with us.
The first variation is the most simple one.
Here’s the criteria: Sell ARKK short when the 5 EMA crosses under the 7 EMA and close the short when the 5 crosses back over the 7.
Over the past year and a bit, these are the results. It produces a positive return, but not necessarily the best return. 2.10% return vs -5.88% for ARKK.
Here are the results over a longer timeframe. Not too great. -35% return vs 143% for ARKK.
However, there are some important things we need to consider here.
This obviously doesn’t perform well because it is shorting ARKK even in strong underlying uptrends as long as one simple short-term criteria is met, without even considering any other fundamental factors. We doubt Puru would just short based off that one factor.
Not to mention, we are only exiting the trades when the moving average crosses back over (to keep the backtest simple), but in reality, the exits could be much different and could be based on key support/resistance levels.
Also, the strategy of course performs much better when ARKK is experiencing longer-term drawdowns, as you can probably tell from the charts above.
So, lets tweak it a bit. If we’re going to follow trends, we might as well only short when the underlying trend is actually down.
Strategy Tweak - Using the 200 SMA
To avoid shorting into strong uptrends, this strategy adds just one extra indicator.
Criteria: Short ARKK when 5-day EMA crosses under 7 EMA, but ONLY if the stock price is also under the 200-day simple moving average. Exit conditions: cover the short when 5 and 7 cross back over (regardless of the 200 day moving average)
So, for example, if the MA’s crossed under, it wouldn’t short if ARKK is above its 200 SMA. Only if it’s lower. Here are the results since ~ November 2020.
This is exactly what you want to see from a hedging strategy. Positive returns - and nice ones too. 16.77% returns, with a max drawdown of 7.35% and a beta vs. ARKK of -0.19.
Below are the exact entries and exits in that period (hopefully its easily visible). This strategy avoided shorting the strong run up from November 2020 to February 2021 and only shorted once the trend was already weak.
The first short came in July 2021. In fact, if you look close enough, it signalled another short on December 29, just a few days ago.
Below are the results if you extend the backtest to start around January 2018.
Not AS good, but still not bad. The 24% max drawdown is a bit ugly, but the returns are positive, which technically means you would’ve protected your downside by making that extra 5.56% on the short side.
Remember, you can hold long positions for the most part when you are not short ARKK. You don’t have to exclusively short. Therefore, holding long, PLUS the positive returns from hedging at the right times, would allow you to probably outperform ARKK in this scenario.
Let’s extend the testing period a bit longer.
Starting in ~ October 2014, hedging with this strategy gave a 27.66% return. Pretty good if you consider what we wrote above.
Can You Use the Opposite Strategy to Go Long?
First, let’s test just the 5 and 7 EMA’s. The strategy will be flipped though.
Criteria: BUY ARKK when 5-day EMA crosses OVER 7-day EMA. Close long when 5 crosses under 7 EMA.
Here are the results: 235.75% return vs 373.6%. While you may look at this and say that it sucks because it underperformed, there are things you need to consider.
The max drawdown for the strategy was 30%. This is actually not bad relative to ARKK because ARKK’s max drawdown around this period is about ~45%+ (from the COVID-19 crash), and there was also another 44% drawdown from Feb 2021 highs to December lows.
Also worth mentioning, there seems to be only one major drawdown period in this strategy compared to 2 or more for ARKK. The beta is also 0.51, about half as volatile as ARKK, but with more than half of its share price appreciation (half would be a 186.8% return). So, you get less overall return, but with much less volatility as well.
Combining the 20-Day Moving Average in the Long Strategy
Now, here’s where it gets a bit better. We’ll combine the 20 day SMA for going long (20, not 200, it’s not a typo)
Criteria: BUY ARKK when 5-day EMA crosses OVER 7-day EMA but ONLY if price is above the 20 SMA. Close long when 5 crosses under 7 EMA regardless of 20 SMA.
Here, the performance is slightly lower than the one tested above, but it is arguably better because the max drawdown drops to 25.26% while the return is still good at 224%. ARKK’s max drawdown of 45.5% (COVID crash) is 1.8x higher.
Combining Both Long and Short
Unfortunately, we can’t backtest a both long/short strategy, but you’ve seen the positive returns of the short strategy (with 200 SMA combination). Therefore, if you combined both strategies, you’d most likely have even higher returns than just using one exclusively.
This will allow you take advantage of both uptrends and downtrends and since you’re not fully invested all the time, you avoid a large part of the drawdowns.
Important Notes
We only tested ARKK stock above because that’s a common hedge ticker that Puru uses. There are no guarantees that this strategy works well with other tickers like SPY (in fact, it doesn’t really work so well on SPY, we quickly tested that and the returns were negative for hedging).
Also, these are just backtests and not real-life results. Finally, past performance is not indicative of future results, so there really are no guarantees of future success here; we are simply just presenting information.
The Takeaway
It seems as though the 5 and 7 EMA hedging strategy works on ARKK, especially recently, which is the most important part. If something is working NOW, then stick to it. It also seems to work much better when combined with another downtrend indicator like price being below the 200 SMA.
The strategy also has worked on the flip side for going long. Combine the two, and you could be golden.
If you’d like to backtest these or other strategies yourself, check out TrendSpider here. They have a 50% off new year’s sale and it ends in a few hours! TrendSpider is a great platform for charting, backtesting, and more.
Also, check out this article we wrote last year where we show other moving average backtests. If you want to learn HOW to backtest, we also have another article here titled How to Backtest a Trading Strategy - No Coding Required.
Twitter: @StockBrosTrades