Trend Investing in Choppy Markets

Well... since last January being a trend investor has not been especially fun. U.S. markets have been stopped three times. The international equity markets haven't been doing too well at all; they more or less broke down near the end of January 2018, most countries have dropped substantially, and, based on my momentum scoring, they are on the slide again despite the signs of optimism earlier this year.

Only U.S. stocks have made new highs since January 2018, but even there it has been a range-bound and choppy market. New highs haven't carried the momentum we like to see in a strong market. We have also seen a pick up in volatility.

Take a look at the size of the weekly bars in the red areas compared to the black area.

Right-click to expand image.

These factors spell trouble for any trend investor. Trend investing performs the best in smooth uptrending markets or in longer downtrending markets. We go with the uptrend and capitalize with leverage where we can. In a long downtrend we sit on the sidelines in cash or bonds and watch the markets burn.

These types of market conditions in stocks are not rare. This is, after all, why trend investing works. Great recent examples of clean uptrends are from March 2016 through January 2018. Or before that from January 2012 through September 2014. These are two year holding periods where trend investors capitalized. In my own account I generated a 68 percent return in the latest period.

On the downside, we all remember October 2007 to March 2009. I had no money back then, so it didn't really affect me. But the S&P 500 fell 55 percent. The trend investor using my model would be off by just 13 percent. For those interested, we're more than halfway there already in 2019.

We see a more recent picture of the protection that trend investing offers by looking outside of the United States. Emerging markets fell around 27 percent from January to December 2018. A trend investor would have been down 14 percent.

Stretching back, emerging markets are down more than 25 percent since 2007. Not a profitable investment for a buy-and-hold investor patiently waiting—with their money tied up—for more than a decade. The trend investor would be roughly flat in their emerging markets trading during the same time period, but could have profited over the years by putting their money to better use when the trend model prescribed no allocation to emerging markets (often for many months at a time).

Of course this is all without factoring in leverage—which rewards handsomely but also punishes cruelly.

The Big Picture

Trend investing offers a good long-term outcome considering there is no crystal ball. We only know what happened yesterday, last week, or in the past years. That's the data a trend investor can use to try get a long-term, but certainly not easy, edge in the portfolio.

As a trend investor, it's important to recognize different market conditions. Markets which are expected to be good for your style and markets which are not. In choppy markets—the markets of today—you will lose money. That's what happens when stocks are not trending well.

Too often we hear from the boisterous crowds employing hindsight bias and capitalizing on narrow time frames. Of course with a crystal ball we would have invested (with ample leverage) in emerging markets from 2004 to 2007, went to long-term bonds until March 2009, then put all of our money in U.S. tech stocks until today. But no one did.

As humans using their superior discretion it's more likely that in 2007 they were diving greedily into emerging markets. By 2009 they were exhausted by the losses and switched to cash. And this past year they are finally buying tech stocks on the dips hoping to catch the rise of Netflix, Uber, Lyft, and Amazon (after all, even Mr. Buffett is buying it now).

Stick with the trend. Ignore the noise. With a lot of patience, a little alignment of the stars, a few whipsaw trades, and a bit of leverage I'm pretty confident I'll be much wealthier ten or twenty years from now. You should be too.

Trend investing may be the only quantifiable, repeatable, and diversifiable way to invest in a broad range of markets with a long-term edge.

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