Britain goes to the polls in less than 10 days, on 8th June, to select a new government in a General Election.
It’s a public holiday today in the world’s two major Forex trading centers (London and New York), so it is not a great surprise that today’s market movements are thin and light. Monday is typically a relatively quiet day in the market, anyway. As there is not a lot going on, I thought I would try to expand a little more on what I wrote yesterday about trend following, or “trend trading” as it is often called.
I already outlined the major pros and cons of trend trading for retail traders, then went on to present a long-term back test of a strategy where long or short trades in a basket of assets are entered depending upon whether the price of an asset has gone up or down over the previous month. The strategy would have produced an annualized return of 11.78%, but with a very large maximum draw-down of 120%, which makes such a strategy difficult to trade. There are a couple of interesting places this observation can lead us to.
Firstly, maybe 1 month is an overly short-term period. Couldn’t we do much better if we traded with the long-term trend? To find out, I applied a filter where trades are only taken if the price has moved in the same direction over the previous 12 months as it has over the previous 1 month. Applying this filter, the return from 2001 to 2016 decreases from 443.60% to 365.71%, which works out to an annualized return of approximately 10.65% instead of 11.78%. This number is better than it looks, for this strategy is in the market less than the 1 month strategy, so the costs of spreads, commissions, and overnight financing are all lower. The worst draw-down, was only 93% compared to 120%. The total return for every asset in the basket, including each Forex currency pair, was positive. It should be noted however, that the Forex assets produced the lowest returns: further proof of the relatively low propensity to trend of fiat currencies. If we remove the Forex assets, we get a better risk-adjusted return: 316%, with a maximum draw-down of only 54%. I am not the first author to note that while diversification tends to lower risk in “normal” markets, during periods of great shock such as 2008, it seems that all the trends can unwind at once, producing surprisingly large losses. The chart below shows all assets in blue, and non-Forex assets in Gold:
Another issue which I will get into later is how results can usually be improved by adjusting position sizing to the current volatility of each asset. This works because volatility tends to cluster.
I’ve been writing lately about how the bullish stock market, especially in the U.S.A., makes a lot of sense to follow, especially if you are a trend follower. Trend following is the simplest and easiest way to give yourself a good chance of making money as a novice in the market, because it is a well-observed trading edge which you do not need expertise to implement.
I mentioned yesterday that the U.S. stock market is still very strong, with the key benchmark S&P 500 Index, composed of the 500 largest U.S. stocks by market capitalization, was only about 10 points off an all-time high. I’ve also written before about how important all-time highs are in stock markets, as a good statistical indicator that still higher prices are going to happen shortly. Furthermore, there is no stock market in history that has done as well as consistently in terms of prices going up, as the U.S. stock market. These factors add up to a convincing case that it’s beneficial to be long of major U.S. stocks or the major stock index right now. Continue reading…
The patterns within the Forex market over the past several days are showing some initial signs of changing, as the start of the New York session approaches.
Last week was a strong week for the Euro: the currency rose by more than 2% against the U.S. Dollar, partly due to weakness in the Dollar, partly due to the market finding renewed faith in the success of the European project following Emmanuel Macron’s victory in the French Presidential election.
The British Pound / U.S. Dollar currency pair has been coiling up under 1.3000, while still clearly within a long-term trend.
I wrote yesterday about how journalists were attributing the Euro’s recent weakness to President Trump’s political problems.