Markets I Trade: November 13, 2018

I often get asked questions about my personal investing process. To try answer some of these questions, and to journal and track my own trading progress, I am starting this new post series called "Markets I Trade". Bear with me as I develop the post format and feel free to offer any suggestions by emailing me or leaving a comment.

In my registered accounts, I follow a Dual Momentum method that is based on the signals I share each month on this blog. However, in my non-registered investment account I use a trend following strategy.

Trend following is a very broad category of investing based on price action only. Using longer-term trends on the price, the investor makes bets that the price will increase or decrease (depending on the signal) and uses careful risk management practices. There is no fundamental evaluation, there are no predictions, there are no profit targets.

The goal is to track numerous markets and benefit from a relatively small mathematical edge over time. Stop losses are used to limit the size of the maximum initial loss on each trade and to get out of an asset once the trend is complete.

In trend following, every trade should end in a small loss, a small gain, or a large gain. There should be no losses that exceed the maximum risk you are willing to take. This means no holding onto a trade that is going against you, and definitely no "averaging down" on a trade.

You can be a trend follower across many different markets: stocks, mutual funds, ETFs, options, futures contracts, bonds, precious metals, currency pairs, and so on. Anything that has a price, moves in trends, and is investable is fair game.

My Personal Trend Investing Strategy

In my personal account, I am developing my trend following strategy continuously. Due to account size, my brokerage, my location, and my experience, I am somewhat limited in what I can effectively trade at this time.

I try to limit my investing process to the most liquid markets that have the highest potential for bigger price movements. This generally means ETFs, some leveraged ETFs, the USD/CAD currency pair, and certain emerging market currencies against the Canadian dollar or U.S. dollar.

Thankfully this covers a large portion of the investable market, especially with ETFs which track many different markets and provide exposure to currency movements (unhedged country ETFs). I am hoping to open up my trading to include LEAPS options in the near future.

I typically use volatility-based breakouts to identify a trend entry and exit. Using volatility measures makes it easy to size each position and limit initial losses. This means pre-determined exit points and fewer short-term whipsaw trades than some other measures.

In a currency pair trade, I have found that moving average indicators can be quite effective as well. The challenge with using moving averages is that you don't have the same embedded exit points to help determine position sizing. This makes moving averages more effective for trading my two primary account currencies—the USD/CAD pair—than most other markets.

I don't try position size the USD/CAD pair as I am equally happy with my account cash being 100 percent in the Canadian dollar or 100 percent in the U.S. dollar. I also don't take a negative position on either currency. It's just a way to determine in which currency I should hold a positive cash balance.

Brazil: EWZ

In early October I took an upside position in Brazilian stocks. I used EWZ, the iShares MSCI Brazil Capped Index ETF, to measure my signals including entry points and initial risk.

EWZ is an unhedged country ETF. This means it provides exposure to both Brazilian stocks and the Brazilian real. Both of these have been absolutely pummeled in the last decade.

USD/BRL Currency Pair (Monthly Bar)

Source: Yahoo Finance

Since of low of nearly 1.5 reals per U.S. dollar in July 2011, the value of the real has fallen more than 62 percent to more than 4 reals per U.S. dollar. This month, the Brazilian real is at approximately 3.7 per U.S. dollar.

Of course this fall has significantly impact the value of Brazilian stocks when priced in U.S. dollars.

EWZ—MSCI Brazil Capped ETF (Monthly Bar)

Source: Yahoo Finance

Since the "BRICS-craze" up-cycle high in 2008, the value of EWZ has dropped big time. In 2016, it hit a low point at an 82 percent drawdown! The value of EWZ has roughly doubled since early 2016—which is starting to look like the down-cycle low point.

The influence of the currency is very prominent on EWZ's valuation. When we overlay the inverse BRZ/USD currency pair over the EWZ chart, we see a very strong correlation between the two.

Source: Yahoo Finance

EWZ—A Closer Look (Daily Bar)

Source: Yahoo Finance

This chart shows the buy signal (green circle) and initial stop loss level of my Brazilian stock trade. I purchased at approximately $33.70 and sized my position based on a stop loss level of $30.70.

Using these figures, I purchased about $80,000 of exposure to Brazilian stocks when measured in Canadian dollars. I was willing to lose up to about $8,000 on this trade at the entry point.

Currently, the trade is in profit and my stop loss level has moved up around $35.50 which is a little above my purchase level. Barring any significant gap over my stop loss level, I will at least be making a small profit on this trade when it comes time to close the position.

Comments & Questions

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8 Replies to “Markets I Trade: November 13, 2018”

  1. Thanks for the post – looking forward to more of this new series.

    You mentioned in your registered accounts, you follow a Dual Momentum method and in your non-registered investment account you use a trend following strategy. Does this mean you are not currently employing your leveraged barbell strategy? If yes, how come?

    Also, a general point for the series. Could you also devote some time to explaining your methodology of looking for, and finding trend opportunities. I.e. do you have a watchlist, screener, follow geopolitical news / current events, etc. How do you monitor for trend following opportunities and avoid range bound activity?


    1. Daren (Editor) says:

      My trend following strategy is actually a type of leveraged barbell strategy. Unless all the stars align (2016-2017 for example), most of my trend portfolio is in the safe stuff. Bonds, cash, currencies. A small amount is in leveraged exposure to equities based on trend with a stop loss. Since I recently got stopped out of my gold position, my trend portfolio right now is well over 90% safe stuff.

  2. Hi Daren…By “volatility-based breakouts” do you mean using indicators such as ATR?

    1. Daren (Editor) says:

      Yes, ATR with moving average: the Keltner Channel.
      ATR trailing stops are also something to consider. It has a very similar effect to certain Keltner Channel configurations.

  3. Thanks for the previous answer Daren. Here’s a follow up question:

    How does the Keltner Channel make it easy to size each position and limit the initial lossses?

    1. Daren (Editor) says:

      Well your stop would be the bottom of the band. After that, you just run a quick position size calculation like the ones I shared in my risk management posts.
      I personally think it’s smart to run your risk management based off of your indicator, especially if that indicator incorporates volatility.

  4. Easy peasy. I thought it would be more complicated; like using Fibonacci retracements.

    1. Daren (Editor) says:

      Haha! I would have more faith in a palm reader for investment advice.

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