Beruflich Dokumente
Kultur Dokumente
Aconciseguidetotradinglongandshort
CopyrightJBMarwood2014/2015
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withtheCopyright,DesignsandPatentsAct1988.
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DISCLAIMER
Thisbookisaneducationaldocumentandissoldwiththeunderstandingthatneitherthe
authororpublisherwillacceptanyresponsibilityforlossesorriskasadirectorindirectresult
ofusingideas,applicationsortradingsystemsdescribedinthisbook.Tradingsystemsare
presentedinafairandaccuratewaybutmaybenefitfromextratestingandfurther
customisation.Tradinginfinancialinstruments(suchasequities,fixedincome,foreign
exchange,futures,options,CFDsandallothertypesofexchangetradedoroverthecounter
financialinstruments)carriesahighdegreeofriskandisonlysuitableforinvestorswhoare
abletosustainsubstantiallosses.Inthecaseofmargintrading(suchasfutures,options,
CFDsorleveragedequitytradingforinstance),theriskoflosscouldbegreaterthanthe
amounttheinvestorhasinitiallydepositedintohis/heraccount.
Formoretradingideas,systemsandstrategiesvisit:
http://jbmarwood.com
CONTENTS
Introduction
Priceisking
Notjusttechnicalanalysis
Searchingforthelongtail
Trendfollowingbasics
Howtofindatrend
Movingaverages
Breakouts
Otherapproaches
Managingrisk
Stopsornot
Risk:Reward
Trendtradingsystems
Curvefittingandotherbiases
Doestrendfollowingworkonstocks?
Famoustrendfollowers
Whathappenedin2008?
Istrendfollowingdead?
Whatdotrendfollowerssay?
Conclusion
Appendix1.MovingAverageStrategy
Appendix2.29rulesfortrendfollowingonstocks
Appendix3.TrendFollowingForStocks:CompleteTradingSystem
Wikipedia:
Trendfollowingisaninvestmentstrategybasedonthetechnicalanalysisof
marketprices,ratherthanonthefundamentalstrengthsofthecompaniesorsecurities.
Introduction
Ifyoulookataselectionofcharts,itquicklybecomesobviousthatpricestendtomovein
particulardirectionseitherupwardordownwardforextendedperiodsoftime.Often,there
maybenoobviousfundamentalreasonwhythisisoccurringbutitis.Thesearetrendsand
successfultradersgeneratesignificantprofitsbyidentifyingandfollowingthem.
AccordingtotheWikipediadefinitionabove,trendfollowingisbasedontechnicalanalysis.In
reality,Iwouldsaythatthisisonlypartlytrue.
Technicalanalysiscanincludeanynumberofdifferenttechnicalindicatorsandstrategies,
manyofwhichhaveverylittlevalue.Trendfollowingontheotherhandismorephilosophical
thanasimpletechnicalanalysisapproach.
Itisthebeliefthattrendsexistacrossnumerousmarketsandindustriesandevenmore,that
thereisareasonforthemexisting.Itisthebeliefthatthepriceofasecurityisthemost
importantthingtounderstandandeverythingyouneedtoknowaboutamarketcanbe
ascertainedfromitspriceaction.
Itisalsothebeliefthattrendscanlastformuchlongerperiodsthanexpectedandtrend
followingistheapproachdesignedtocapturethelongtailofmarketreturns.
Recentmediacoverageoftrendfollowinginsiststhattheapproachisoutofdateandsome
commentatorshaveevenproclaimedthattrendfollowingisdead.Iwillcometothislateron.
Fornow,letstakealookatwhattrendfollowingisandwhatitisnt.
Priceisking
Investorsusetechnicalanalysistoidentifytrends,todeterminewhentoenterthemarket,and
toformulatetheirexitstrategy.However,thisanalysisisreallytargetedattryingtoanticipate
pricemovementsandpriceistheoverridingprinciplebehindtrendfollowing.
Thekeytenetoftrendanalysisandthemantraoftrendfollowersisthatpricecantell
investorseverythingthatisimportantaboutasecurity.Ittellsthemhowthestockhas
performedinthepast,whereitisnow,andwhatthefutureislikelytoholdforit.
PerformanceofafamoustrendfollowingfundrunbyBillDunn.Src:DUNNCapitalManagement.
Becauseofthis,trendfollowersfocusonpricemovements,ratherthantryingtouse
fundamentalfactorssuchaseconomicdata,geopoliticaleventsandothermacroeconomic
factorstopredictperformance.Inessence,theybelievethatthemarketisalwaysrightand
thatprofitscomefromfollowingwhatthemarketisdoingatthatprecisemomentratherthan
tryingtopredictwhatwillhappennext.
Ifyouconsideralltheinputsandinformationthatexistinthefinancialmarketsyouwillrealise
thatattemptingtounderstandwhatcausesamarkettomoveinacertainwayisnear
impossible.
Forexample,canyoureasonablyexpecttoknowalltheinformationaboutaparticular
companysfinances?Canyouevenbegintounderstandtherelationshipsthatgointothe
supplyanddemandconstraintsofaparticularcommodity?
Trendfollowersarguethatattemptingtoanalysefundamentalsisfutile.Everythingthatyou
needtoknowaboutamarketitreflectedinitsprice.Thepriceisallyouneedtoknowanda
marketthatisgoingupshouldbebought,whileamarketthatisgoingdownshouldbesold.
Notjusttechnicalanalysis
Sometrendfollowersclaimthatwhattheyaredoingisnotjusttechnicalanalysis.Theypoint
totheexistenceoftrendsacrossmanysphereseconomic,political,fashion,technological
toarguethattrendsexistacrossallareas.
Thisisareasonableclaim,butitisworthwhiletorememberthattrendsarealsotiedtounique
marketphenomena.
Forexample,investorenthusiasmcandrivetrendstoextremeswithoutanyfundamental
underpinningintheendthiscanmakethemsusceptibletopainfulreversalsbutthetrend
followerwillusuallyhavemademanyhundredsofpercentalongtheway.
Thedot.comboomisagoodexampleofthis,buttherearemanymorerepresentativecases
throughouthistory,includingtheDutchTulipManiainthe17thcentury,andtheSouthSea
Bubbleinthe1800s.
Therearealsoshorttermfactorsatplay,suchaswhenthemarketbecomesoverboughtor
oversoldwhichcanleadtoatrendstallingorevenreversing.Thissortofshortterm
technicalphenomenonreallyhasnoexactcorollaryinotherareasoutsideofthemarkets.
Searchingforthelongtail
Backin1909,HenryFordmadethestatementthatAnycustomercanhaveacarpaintedany
colourthathewantssolongasitisblack.ThiswasinreferencetotheModelT,thecarthat
madeFordapowerhouseintheautomotiveindustry.Thisisaperfectexampleofmass
marketing,whichtargetsthevastmajorityofconsumerswithaverynarrowproductoffering.
Infact,thisiscapturedinthe80/20ruleorParetoprinciplewhichassertsthat80%of
casescanbeaddressedbycovering20%ofthetotalsetofrequirements.Thisisa
characteristicofmanymathematicaldistributions,whichseethevastmajorityofitems
clusteredcloselytogetherwithonlyafewoutliers.
However,thisprincipledoesntalwaysholdparticularlyincaseswherethereisalongtail
distribution.Thisiswhenadisproportionatelyhighnumberofcaseslieoutsideofthecentral
peakofthedistribution.
Thisdistributioncanbeseeninmanyareassuchasrecenttrendstowardsmass
personalization,aswellasthesuccessofcompaniessuchasAmazon,whichtargetthelong
tailwithahugearrayofproducts,ratherthansellingafewproductstoamassmarket.
Infact,inalongtaildistribution,lessthan50%ofcasesfallintothatcore20%of
requirements,makingchasingthelongtailhighlyprofitableformanybusinesses.
Thesamelongtailprincipleappliesforinvestorswhofollowtrends.Longtailsare
characteristicoffinancialmarketsforexample,ifyoulookatabroadselectionofstock
returns,youllfindthatsomeofthemmoverelativelylittleoverayearmaybe5%or10%
buttherearealsoadisproportionatelyhighnumberofstocksthatmakemuchlargerprice
moves50%,100%,200%orevenmoreinsomecases.Thesearethelongtailstocksthat
trendfollowersarehunting,sincetheyofferthebiggestopportunityforprofits.
Trendfollowingbasics
Becausetrendfollowersaretryingtocatchthelongtail,theytypicallyadoptarelatively
straightforwardstrategy.Theybuywhenthemarketisrising,andsellwhenitsonitsway
down.Whattheyhopeisthattheyaregettinginonthestartofatrend,whichtheythenrideto
itsprofitableconclusion.Theydontactuallycarewhetherthemarketisrisingorfallingthey
areunbiasedandcanmakeprofitsinbothcases.
However,becauseofthelongtailnatureofthemarket,someofthesetrendswillbe
shortlivedorevennonexistent.Itsabitlikewavesatseatherearetinyripples,some
biggerwavesandtheoccasionalmonster.Thebigwavesandthemonstersarewheretrend
followersmaketheirprofitsbut,theyalsofindthemselvestryingtoridetheripples.Worse
still,theyfindthatthewaveismovinginthewrongdirectiontheyexpecttobeliftedup,but
theyfindthemselvesfallingofftheotherside.
Becauseofthis,trendfollowersnotonlyneedtojumponwavesthatlookhopefulinother
words,arisingorfallingstocktheyalsoneedtobepreparedforwhenthingsgowrong.
Whiletheyneedtoridethewinnerstotheirconclusion,theyalsoneedtogetoutquicklyand
cuttheirlossesonlosingtrades.Iftheydidntdothis,thelosseswouldoverwhelmthewins,
leadingtoaninevitableandcostlyresult.Inotherwords,thegoalistohaveafewbigwins
thatmorethanoffsetalargernumberofsmalllosses.
Inreferencetothesurfingterminology,trendfollowingisaboutgettingbackontheboardand
waitingpatientlyuntilthebigwavecomesinandridingitintoshore.Onebigwavecanmake
upforalltheothersmaller,missedwaves.
Howtofindatrend
Traderswhofollowtrendstypicallyusetechnicalindicatorsratherthanrawpricechartsto
identifytrends.
Theydothisbecauseindicatorsprovideanobjectivewayofestablishingwhenatrendis
underwayandtheyareeasytoprogramintotrendfollowingtradingsystems.Evenso,some
tradersdorelyonnakedpricedataknownaspriceactiontofindtrends.Thoughthisisa
muchmoreriskyapproach.
Movingaverages
Oneofthemostpopularindicatorsforidentifyingtrendsisamovingaverage.Thisisbasically
theaverageofthepriceforthepreviousseveraltradingintervals.Whenasmallernumberof
intervalsisused,thisisknownasafastmovingaverage,sinceitreactsquicklytochangesin
price.
Whenalargernumberofintervalsareusedaslowmovingaveragethenthistendsto
changemoreslowly.Thebenefitsofusingamovingaveragearethatittendstoeliminateany
shorttermfluctuationsinthemarket,givingamoreaccurateviewoftheoverallmarket
direction.
Tradersusemovingaveragestodeterminewhetherornotatrendisdevelopingandtypically
usetwomovingaveragestogetherafastoneandaslowone.
Whenthefastmovingaveragecrossesovertheslowone,thisisanindicationthatanupward
trendisunderwayandisusuallyastrongbuysignal.
Ifthefastmovingaveragethenfallsbelowtheslowmovingaverage,adownwardtrendis
underwayandthetrendtraderwillsell.
Breakouts
Anotherpopularwayofspottingatrendistolookforbreakoutsthesearerelativelyeasyto
seeoncharts.
Here,thetraderwilllookforapricetobreakoutofitstradingrangeandmakeanewhigh.For
instance,ifthestockhasbeentradingbetween$2.20and$2.30forthelast50days,andthen
risesto$2.35,thenthisisastrongsignalthatanupwardtrendmaybeforming.Different
tradersusedifferentintervalsthe50dayintervalaboveisjustanexamplesincethereare
differingopinionsonwhichintervalspredictthemarketmostaccurately.
Mosttrendfollowersusetradingprogramstotestwhichtimeintervalsworkbestforfinding
profitablebreakoutsthenworktheseintotheirtradingsystems.
Otherapproaches
Therearehundredsofotherindicatorsthattrendtraderscanuse.Manytradersusetheseto
getanextraedge,buttheriskisthattheymaketradingtoocomplicatedwhichcanleadto
mistakes.
SomeofthemostpopularoftheseotherindicatorsincludeBollingerBandsandmoving
averageconvergence/divergence(MACD).Anotherpopularindicatoristherelativestrength
index(RSI),whichmeasureshowstronglythemarketismovingupordown.Thisisusedboth
todeterminewhenthetrendisstrongandlikelytocontinueaswellaswhenthetrendis
toostrong,inwhichcasethemarketmaybecomeoverboughtoroversold,leadingtoaprice
trendreversal.
Ultimately,itsimportanttofocusontheendgoal,whichistocapitaliseonlongtermtrends.
Simplestrategiesoftenworkjustaswellasmorecomplexonesinthis.
Managingrisk
Asdiscussedpreviously,trendtradersdonotexpecttomakeaprofitoneverytrade.
Generally,trendfollowerswinaround30%40%oftrades.
Becauseofthis,itbecomesveryimportantforthemtolimittheamounttheyloseonthe
tradesthatdontworkout.Thisisthedisciplineofriskmanagement.
Thefirstprincipleofriskmanagementisnottoriskadisproportionatelylargeamountofyour
totalcapital.Mosttraderswilllimittheirrisktolessthan2%onanyonetrademeaning,for
example,thattheywillnotriskmorethan$200iftheirtotalcapitalis$10,000.
Ofcourse,thatdoesntmeanthattheyonlymakea$200investment.Whatitdoesmeanis
thattheylookatthemaximumthattheycanloseonthetrade,andthenusethistoestablish
howmuchtheyinvest.
Forexample,theymightbuyastockat$2.10,andthenplaceastoporderwhichistriggeredif
thestockhits$2.00.Theyareexpectingthestocktorise,butifitdoesfall,thenthemaximum
thattheycanloseis$0.10pershare.Thismeansthattheycanaffordtobuy2000sharesand
onlyrisk$200.Inthiscase,theirtotalinvestmentis$4200whichissignificantlymorethan
the$200theyarerisking.
Stopsornot
Importantly,sometrendfollowersmayusestopsandsomemaynot.
Intheexampleabove,usingastoplosslimitsthedownsideofapotentiallosingtradebutit
alsoensuresthatyouexitatradeataloss.
Itsforthisreasonthatsometrendfollowersfindstoplossescanunderminetheiroverall
performance.Inthisinstance,itsworthdoingsomeinvestigationintowhatkindsofstops
workthebestforthestrategyinquestion.
SometraderspreferdifferenttypesofstopssuchastheChandelierstoporvolatility
measuredstops.Othertradersprefertousestopsthatonlygettriggeredveryoccasionally.
Theyreasonthatastopoftenexitsatradeattheworstpossibletime.Itsthereforefarbetter
touseanexitstrategythatdoesnotinvolveastoploss.
Forexample,ifyoubuyamarketonaEMAcrossover,youshouldsellonanEMAcrossover
too.Byoptimisingriskyoucanestimatethatyouraveragelossrarelyexceeds1%or2%.This
canbepreferabletoriskingaset1%or2%oneverytradesincemarketsareneverso
predictable.
Risk:reward
Traderswillalsolooktoseeagoodrisk/rewardratioontheirtrade.Forexample,iftheyare
risking$0.10pershare,asintheexampleabove,thentheywilltypicallylookforatrade
wherethepotentialprofitisthreetimesormoretheyareexpectingthestocktogoupbyat
least$0.30.Infact,sometraderswilllookforamultipleof5to1.
Toestablishwhatthepotentialprofitis,theywillanalyzesimilarpasthistoricaltrades,andwill
alsolookatothertechnicalindicatorstodeterminewhatthepricemovementislikelytobe.
Trendtradingsystems
Trendtraderstendtotakeamathematicalapproachtotrading,relyingonindicatorstodecide
whichstockstotradeandwhen.Unlikefundamentaltraders,whotendtoapplymore
individualjudgment,trendtraderstendtosticktothenumbers.
Wevealreadydiscussedoneexampleofthisusingcrossovermovingaveragesasasignal.
Infact,oneofthemostcommonoftheseiswhenthe50daymovingaveragerisesabovethe
200daymovingaverage,crossingitfrombeneaththisisknownasagoldencross.
Similarly,whentheoppositecrosshappensthe50dayaveragefallsbelowthe200dayone
thisisknownasadeathcross.Onesystemcouldbetobuywhenagoldencrossoccurs,
andsellwhenadeathcrossshowsup.
Becausethisisaverywelldefinedstrategy,itiseasytogobackandseeifthestrategywould
havegeneratedprofitsusinghistoricaldata.Thetrendtradercanthendiscardanystrategies
thatobviouslydontwork,andthenoptimizetheonesthatdobychangingtheparameters
forexample,usingperiodsotherthan50and200forthetwomovingaverages.
Ofcourse,thisisaverysimpleexampleofatradingsystemandbecauseofitsnotorietyits
unlikelythatitwillproducestaggeringreturnsanymore.Trendfollowingsystemscanbemuch
morecomplicatedofcourse.
Becausetheyareallwelldefined,theyarerelativelyeasytoautomateusingcomputerized
tradingsystems.Thisnotonlyreducestheamountofmanualworkthatthetraderneedsto
do,italsotakesalotoftheemotionoutoftheequationwhichisimportant,sinceemotions
oftenleadtotradingmistakes.
Eveniftheyareabletocompletelyautomatetheirtrading,however,trendtradersshouldnt
maketheirsystemstoocomplex.Firstofall,thismeansthattheycouldfailinunexpected
waysmorecomplexitymakessystemsmoreunpredictable.Atthesametime,thereisthe
riskthattheydevelopasystemthatfitsallthehistoricaldataperfectlyjustbecauseithas
beentunedtodothatbutreallyhasnovaliditywhenitcomestoanticipatingfuturemarket
behavior.
Curvefittingandotherbiases
Indeed,tradingsystemsthatworkwellonpastdatadonotalwaysworkwellonfuturedata.
Curvefittingasystemtopastdataisjustoneofanumberofbiasesthatatraderneedsto
overcomeinordertodevelopasystemthatisrobustandreadytouseonrealmarkets.
Selectionbiasdictatesthatatradingsystemsperformancecouldjustbebychance,while
survivorshipbiascanimpactonasystembynottakingintoaccountsecuritiesthathavesince
fallenoffoftheexchange.
Tradersneedtounderstandtheprinciplesofsoundsystemdesigninordertocreateasystem
thatwillnotfailonlivemarkets.Sincethereisnoquickerwaytothepoorhousethanby
followingabadlydesignedtradingsystem
Doestrendfollowingworkonstocks?
Beforewegomuchfurtheritsworthdemystifyingacoupleofthingsaboutsuccessfultrend
following.
Firstly,thereareveryfewtrendfollowingfundsintheworldthattradestocksaloneandthe
reasonforthisisthatacoreelementofsuccessfultrendfollowingisdiversification.
Putsimply,individualstocksareverycloselycorrelatedtheytendtoallmoveuptogetherand
allmovedowntogetherthereforetrendfollowingonstocksneedstobedoneslightly
differently.
Instead,mosttrendfollowingfundsarerunbyCTAs(commoditytradingadvisors)andthey
typicallytradeadiversifiedbasketofdifferentfutures.Commoditiessuchasgold,wheat,
crudeoil,bondssuchasUSTreasuries,currenciesandstockindices.
Manytrendfollowingfundstradearound60differentfuturesmarketsandtheyusecorrelation
matrixestospreadtheirriskoverdifferenttypesofmarkets.
Butbacktotrendfollowingonstocksanditsclearthatthestrategycanperformwellon
stockssolongasitistailoredsufficiently.
Thereareseveralacademicpapersthatsuggesttrendfollowingisaviableoptionwhen
tradingstocksbuttherearesomekeytakeawaystotakenoteof.
Firstly,shortingstocksisshowntobenotveryeffectiveintrendfollowingmodelssincestocks
haveaninherentupwardbias.Unlikeacurrencypairwhichisunbiasedtoeitherdirection,
moststocksareproductiveassetsthatmovehigherovertimeaccordingtoearningsand
inflation.
Asaresult,diversificationwhentrendfollowingstocksishardtocomebyandthismeansthat
atrendfollowingapproachcannotbeexpectedtoperformatitsmaximumallthetime.
Therewillcomebearmarketyearswherestocksgodownandinthisinstance,atrend
followingstockportfoliowillfinditnearimpossibletomakemoney.
Thesolutiontothismaybetofindafilterormarkettimingmechanismsomewaytoswitch
outofstockswhentheoverallmarketisenteringabearstage.Perhaps,whenthebroader
marketindexistrendingdown,trendfollowingfundscanmoveoutofstocksandintocash,or
bonds.
Overall,theevidencesuggeststhattrendfollowingworksonstocksforthesamereasonit
worksonothermarketsitenablesthecaptureoflongtailreturns,thestocksthatgoupand
upandup.
Famoustrendfollowers
Interestinglyenough,onceyoutakeoutfamousinvestorssuchasWarrenBuffettorGeorge
Soros,someofthemostfamoustradersofalltimecanbedescribedastrendfollowers.
(EvenGeorgeSoros,whotakesaheavyfundamentalapproachtotrading,reliesonriding
trendsandhisowntheoryofreflexivity.Inaway,Sorostechniqueisbasedonfollowing
trendsandstayingwithmarketsthataremovinginonedirection).
OneofthemostwellknowntrendfollowersisJesseLivermore,atraderfromtheGreat
DepressionerawhowasimmortalisedintheclassictradingbookReminiscencesofaStock
Operator.Livermoremadeandlostmanyfortunesduringhiscareerandhiswritingsarestill
thecornerstoneofmoderntrendfollowingstrategies.
Livermorewouldnothavehadamechanicalsystemassuch,butwhathedidhave,wasan
abilitytobuystocksthatweregoingupandsellstocksthatweregoingdown.Healso
preferredtocutlossesshortandlearntfromexperiencethattherewasoftenmoremoneyto
bemadebydoingnothingthanbytryingtocatcheverylittlemoveinthemarket.
AlittlelaterthanLivermore,NicholasDarvaswasanothertrendfollowerwhomadeitbigin
themarkets,turning$25,000into$2,000,000injustacoupleofyearsduringthe1950s.
Darvasapproachwasbasedonboxes.Hewoulddrawboxesaroundtherecentpriceaction
andwhenastockbrokeoutoftheboxhewouldbuyitandridethetrendhigher.Whenthe
stockfellbackintotheboxhewouldsellandhewouldalwayspreferthestrongestmomentum
stocks.
ThelateRichardDonchianwasanothertrendfollowingpioneerwhowasaroundfromthe
1960sandDonchianalsobegantheprocessofcomputerisedtradingwhichinspiredfellow
trendfollowerEdSeykota.
OtherfamoustrendfollowersincludeRichardDennisandtheTurtleTraderswhowere
profiledintheoriginalMarketWizardsbookbyJackSchwager.Dennismademanymillions
tradingasimplebreakoutstrategyinthecommoditiesmarketsandtaughtthestrategytoa
bunchofstudentswhohadnoexperienceinthemarkets,whoultimatelyalsomademillionsof
dollars.
WilliamEckhardtwasDennispartneratthetime,andEckhardtstilloperateshisflagship
trendfollowingfundtoday.Itsbeengoingsince1980sandhasover$300millionassets
undermanagement.
OtherhighprofiletrendfollowingfundsthatareinoperationtodayincludeBillDunnsDunn
Capitalwhichreturnedover50%in2008,MichaelClarkesClarkeCapital(foundedin1993)
andDavidHardingsWintonCapitalwhichholdsover$24billioninassets.
Indeed,2008wasastandoutyearfortrendfollowingfundsasthestrategywasabletomake
moneywhilenearlyeveryotherstrategyfelldeepintothered.
Followingisalargerlistofhighprofiletrendfollowingfundsthatexisttoday:
AbrahamTradingfoundedbySalemAbraham.
AltisPartners.
BeachHorizonfoundedbyDavidBeach.
BlueTrend,fromBlueCrestCapital.
Campbell&Company.
ChesapeakeCapitalfoundedbyJerryParker.
ClarkeCapitalfoundedbyMichaelClarke.
CovenantCapital.
DruryCapitalInc.
DunnCapitalfoundedbyBillDunn.
EckhardtTrading.
EMCCapitalfoundedbyLizCheval.
HawksbillCapital.
MillburnRidgefield.
MulvaneyCapitalManagement.
SunriseCapital.
Transtrend.
WintonCapital.
Whathappenedin2008?
Asmentionedabove,trendfollowerscleanedupin2008asstockmarketsimplodedandhuge
pricemoveswereseenacrossmanydifferentmarkets.
Oneincorrectassumptionisthattrendfollowersmadeallthatmoneyin2008shortingstocks
butthatisntthecaseatall.Trendfollowersrarelyshortindividualequitiesandalotofthe
moneymadebytrendfollowerswasinotherareas.
Inparticular,trendfollowersmadebigmoneyfromUSTreasuriesandbondswhichsoared
duringthefinancialcrisis.Theywerealsoabletocapturebiggainsincrudeoil,onthelong
side
and
ontheshortsidewhenthecommodityreversed.
Manyalsodidwellinothercommoditymarketsporkbellies,sugarandgold.Andtherewere
bigprofitstobemadetooincurrencypairssuchasGBP/USDandUSD/JPY.
Asmentionedearlier,acrucialpartofsuccessfultrendfollowingisdiversificationandin2008,
wesawmanyuncorrelatedmarketspostbigtrendsindifferentdirections.Nearperfect
conditionsfortrendfollowing.
Istrendfollowingdead?
Since2008,theperformanceoftrendfollowinghasbeenmoresporadiccausingsometo
claimthatthestrategynolongerworks.2011wasaparticularlychoppyyearfortrend
followersandsawmosttrendfollowingfundsfinishtheyearinthered.
Buttheyearseithersideof2011havenotbeenkindeitherandmosttradershavefoundit
hardtomatchtheimpressivereturnswitnessedinstocks.
Belowisachartshowingtheaggregatedperformanceofanumberoftrendfollowingfunds
compiledbyiasg.com.Noticehowtheindexhasbeeninadrawdownsince2011.
Thetableofresultsalsoshowshowtrendfollowinghasbeenlesssuccessfulinrecentyears:
However,thetruthisthattrendfollowinghasbeenclaimednottoworkmanytimesbeforeand
wheneverthatshappeneditsusuallybeenagoodtimetostarttrendfollowingagain.
Itisworthrememberingthattheaveragetrendfollowingfundmademoneynearlyeveryyear
between1994and2009soitsperhapsonlynaturalforthestrategytohaveaslowerperiod.
Especiallyconsideringtheattention,andthereforenewtraders,itsgainedsince2008.
Whatdotrendfollowerssay?
Nevertheless,therearestillsomeoftheopinionthattrendfollowinghasseenitsbestdays.
EvenWintonCapital,oneofthelargesttrendfollowingfunds,releasedapaperarguingthat
althoughtrendfollowingisnotdead,therehasbeenevidenceofadegradationin
performance.
WintonsaidWefindtrendfollowingsystemstobeeffectiveinforecastingfutureprice
movements,butweobserveasignificantandpersistentdeclineintheforecastingabilityof
thosewiththefastestturnover.
HistoricalPerformanceOfTrendFollowing,December2013.
Anditsalsoworthnotingtheclosureofonewellknowntrendfollowingfundin2012thatof
JohnWHenry,whoisalsoowneroftheBostonRedSox.
Moreover,sometrendfollowerslaytheblameattheFederalReserve,claimingthatthe
excessofliquidityhascreatedanartificial,lowinterestrateenvironmentthathasseennormal
trendshardtocomeby.
Forme,thatseemslikeapoorargument.Inmyeyes,trendfollowingispreciselythestrategy
thatisintendedtoprofitfromsuchunusualperiodsofmarketactivity.Hugelevelsofmonetary
stimulusshouldleadtobigtrendsandultimatelybubbles.Thesearethelongtaileventsthat
trendfollowingissupposedtothriveon.
Myhunchisthatitsonlyamatteroftimebeforerecordlevelsofstimulustranslateintohuge
financialtrendsandbubbles,andwhenthathappens,trendfollowingwillhaveitstimeinthe
sunonceagain.
UpdateMarch2015:
AsofMarch2015,itdoesindeedseemthatthenaysayersweretoo
quicktocastasidethestrategyoftrendfollowing.Takealookthroughtheperformanceofthe
majortrendfollowingfundsandyouwillseethat2014wasoneofthebestyearseverfor
trendfollowing.MulvaneyCapitalinparticularreturnedover60%.
Conclusion
Pricetrendshavealwaysbeenandalwayswillbeakeyfeatureoffinancialandequity
markets.Insomecases,theyarelinkedtoexternalevents,butinmanycasestheyaredriven
bytechnicalfactorsorbythesentimentofmarketparticipantsindependentoffundamental
drivers.
Traderswhounderstandthisandcanbothidentifyandexploittrendshavethepotentialto
generatelargeprofits.
However,anyonewhoisconsideringgettingintotrendtradinghastounderstandthattheyare
notgoingtowinallofthetime.Theyneedtotakeascientificapproachtotrendtrading,
eliminatinganyemotionalinvolvementwhetherthatisthethrillofvictoryortheagonyof
defeat.
Giventhatthemajorityoftrendtradeswillnotworkout,theymustntcommittoomuchcapital
toanyonedeal,andmustensurethattheirpotentiallossesarewellunderstoodandlimited.
Appendix
1. Testinga50daymovingaveragestrategyonstocks
Oneverybasicbutpopulartrendfollowingstrategyisbasedonthe50daymovingaverage.
Butcanthissimplestrategycanworkintodaysmarkets?
50DayMovingAverageStrategy
Totestthe50daymovingaveragestrategyIloadeduptheAmibrokertradingplatformand
wrotesomebasiccode.Inthisfirsttest,thesystembuysastockwhenthe50daymoving
averagecrossesoverthe200daymovingaverage.Itsellswhenthe50daymovingaverage
crossesbackunder.
(Thisisaportfoliosystemthatholdsamaximumof10stocksatanyonetime.Riskisdivided
into10equalpositionsandcommissionsaresetat$12pertrade.Thiswastestedonstocks
intheS&P1500USstockuniversebetweenAugust2000andAugust2010.Tradesare
enteredonthenextdayopen.)
Test1:
Buy=50dayMA(closeprice)crossesover200dayMA.
Sell=50dayMAcrossesunder200dayMA.
Results:
CAR:16.94%MaxDrawdown:54%
Source:Amibroker
Asyoucansee,overstocksintheS&P1500between2000and2010,thissimple50day
movingaveragestrategyactuallydidverywell.
BearinmindthatthebuyandholdreturnontheS&P599wasjustover2%(nominalreturn)
overtheperiodwitha57%maximumdrawdown.
2.29rulesfortrendfollowingonstocks
1.Priceiseverything.
2.Ignorethenews.
3.Buyastockwhenitbreaksoutofarange.
4.Sellastockwhenthetrendchanges.
5.Buyastockwhenitmakesanewhigh.
6.Shortastockwhenitmakesanewlow.
7.Itshardertoshortstocksthanitistobuystocks.
8.Somestockstrendmorethanothers.
9.Diversifywhenyoucan.
10.Ignorethewhipsaws.
11.Dontchasethemarket.
12.Letyourwinnersrun.
13.Cutyourlossesshort.
14.Astockcanalwaysgohigherandalwaysgolower.
15.Dontgetoutbeforethetrendchangesdirectionlooktocatchthemiddle.
16.Trendfollowershavemorelosersthanwinners.
17.40%isagoodpercentageofwinnersfortrendfollowingstocks.
18.Putyourstopsfarenoughawaytoallowthetrendtodevelop.
19.Dontfallinlovewithastock.
20.Dontpickbottoms.
21.Dontpicktops.
22.Donttryandpredictthemarketgowiththeflow.
23.Followyoursignals.
24.Tradesmallenoughyouwontgobrokeandlargeenoughtomakeitworthwhile.
25.Compoundyourreturns.
26.Trendfollowingstocksworksbestwithasystem.
27.Backtestyoursystem.
28.Dontforgetdelistedstocks.
29.Sticktothesystem.
3.TrendFollowingForStocks:CompleteTradingSystem
Thereissignificantevidencethattrendfollowingstrategiescanworkjustaswellonstocksas
onfutures.Bigtrendsexistinthestockmarket,justlikeanyotherassetclass.Andexploiting
thosetrendscanbehugelyprofitable.
ItsforthisreasonthatIdecidedtocomeupwithacompletetrendfollowingtradingsystemfor
stocksandmakeitavailabletothosethatareinterested.
Thisstrategyisnotjustabouttherightbuyandsellrules,itsaboutthewholeprocessof
portfoliomanagement,tradingsignals,andfollowingtherightmethodsforgaininganedge.
AlotoftimehasbeenputintotestingdifferentrulesandIamnowverypleasedwiththe
systemsoutofsampleresults,(+45%in2013forexample).Thefullsystemequitycurvecan
beseenbelow:
Astheequitycurveaboveshows,thisisahighperformingstrategywithareasonable
drawdown.Thestrategyhasbeenabletowithstand30yearsofmarketconditions,through
bothbullandbearmarkets.Thissystemwastestedonreliable,survivorshipbiasfreedata
andhasdeliveredmillionsofdollarsintradingprofits.
FormoredetailsaboutTrendFollowingForStocks:AcompleteTradingSystem,
pleasesee
http://jbmarwood.com