Sunday, November 20, 2016

Gearing up for 2017

In recent months, one of the most popular posts on the blog has been 'Trend following is dead - apparently...'

I wrote this back in 2010, based on the fallacy that every few years, people talk about how trading trends no longer works, trend following is so 1980's, etc. All this talk usually coincides with a period of poor or non-performance.

We know that markets always go through different market 'states' - either trending or non-trending, stable or volatile. What we don't know is when they will move from one state to another. And when they do start to trend, we can never predict the magnitude of the resultant trend.

Looking at the performance of the ultra-successful trend following hedge funds, which include some of the former Turtle traders, the majority are showing a year-to-date loss for 2016, and at best a small positive result. You can see the summary results here.

However, a key component of their long-term success is their ability to get through the periods of non-performance to get to those phases where decent returns can be made.

I will talk about this further in my next post, when I look in more detail at a well known trend follower's fund performance record.

I've been through these same cycles in my own trading. 2008 through to 2010 were very good, before I suffered a losing year in 2011. I remember that the change in market conditions was instantaneous – it was like someone flicked a light switch on 01 January, and profits immediately became more difficult to achieve. The volatility that year, particularly in the last quarter, led me to retreat fully to cash for a while, and review my own trading approach.

Following that break, I made one simple change to my own method, based on something I read in a Market Wizards interview, and I went back 'live' on 01 July 2012. 

That change coincided with more favourable conditions being apparent in the markets. The result was a +60.5% return in the second half of 2012, followed by +124.58% in 2013!

Trend following was alive and well. 

The first half of 2014 was good too, before the conditions started changing again, and made things more tricky. I suffered my biggest drawdown and run of consecutive losing trades in the second half of 2014, but still made an overall profit for the year, and made a further profit in 2015. As things stand in 2016, I am showing a small loss year-to-date. This is all detailed here.

Your goal as a trader is to minimise the losses when conditions are against your preferred style of trading, and to maximise the profits when the conditions are in your favour. Eroding your capital when the odds are clearly against you, just to stay 'active' is not very clever.

On that basis, and as strange as it may seem, I am pleased with my performance in 2016. I have kept my overall loss smaller than those suffered in 2011. The changes I have made in my own trading have kept me out of the market more when it is clear that volatility is too high, or when it is clearly apparent that breakouts are not working. Keeping a strict control over the level of portfolio heat I take on helps too.

Of course, there have been two major events in 2016 which have contributed to making things more difficult (at least for me) - the Brexit vote and the US election. Both of these 'known unknowns' caused a spike in volatility, the interpretation of which affects my own ability to get signals and consequently get into trades. As of now, a couple of weeks after the US election, I am still getting no decent setups to look at, hence I remain fully out of the market.

Looking forward, while we do not know when the market state will change, or what even what the catalyst may be, it is certain that with every passing week and month, the odds will slowly increase that the market state will change. New trends can start at any time. 

Of course, this occurs all of the time in individual stocks, up and down, but if you are seeing stocks breaking out and quickly failing, or in a lot of cases setting up but not even triggering an entry, that in itself is a further clue that conditions are not favourable, despite what the major market averages may say.

Your chosen timeframe and parameters will help determine whether conditions are favourable to you or not. As my own preferred timeframe and parameters is towards the shorter-term end of the scale, then the volatility and choppiness can easily lead to a drop off in performance, whereas someone who trades longer-term trends will more than likely be able to embrace that volatility and perform better.

There is always a trade-off in trading - if and when an existing trend finishes, a longer-term method will gave back more in open profits. If a new price move starts, they will get in later as they have to wait longer for an entry signal. In those instances, a shorter-term method will be able to react quicker. These type of issues need to be considered when determining your own preferred timeframe and parameters.

And while I am at the shorter-term end of the trend following scale, to me a trend does not constitute a mad rise over a few days (before dropping straight back down) like those seen in some shipping stocks recently! 

Given the various cycles I have seen, experienced and learned from over the years, the odds are increasing that 2017 will be a lot busier in terms of market participation, with more opportunities to make money in the markets.

I am ready for that - are you?

1 comment:

  1. Thanks for sharing your thoughts on trend following in the current market environment, Steve. It's really interesting to hear how your own trading is faring given the range-bound nature of equity markets the last few quarters.