Trends in Trends
Trading with the trend is the easiest and most statistically reliable edge which can be used to make money in the markets. In this article, we will examine what you might expect from trends in Forex, major stock indices, and commodities, based upon historical data from the last 16 years.
Defining a Trend
In conducting an analysis of several assets over a lengthy period, it makes sense to use a simple measure of trend. Here, the definition is as follows: if the weekly opening price of an asset is above its prices of 13 and 26 weeks ago, it is in an uptrend. If it is below its prices of 13 and 26 weeks ago, it is in a downtrend. If neither of these criteria are met, the asset is not in a trend.
The rough analysis is conducted by assuming that an asset in an uptrend is bought at the open of each week, or sold instead if in a downwards trend. Commissions, spreads, and swaps are not considered as the purpose is only to quantify trend phenomena, not to present a complete trading strategy. No leverage was used. The analysis is mostly conducted over 16 years of historical data, from July 2001 to the end of June 2017.
The U.S. dollar pairs with the highest market volumes were analyzed, and all produced positive trend measurements, except the USD/CHF currency pair. Note that no data was available for the NZD/USD currency pair before 2003.
Maximum peak-to-trough drawdowns are exhibited under “Worst DD”. This is an important statistic, as the ratio of drawdown to return is just as important as total return for intelligent traders. The profit factor is an important metric for trend traders, showing the relation of the total profit to the largest draw-down. The compounded annual growth rate (CAGR) is also shown, which is what the final return would have been equal to, as a return on investment each year, compounded. Here are the weekly results over time, exhibited in graph format:
A few interesting elements can be noted. Firstly, all these currency pairs together produced a CAGR of 5.95% with a maximum draw-down of 91.67%.
A buy and hold strategy applied to the S&P 500 index of major U.S. shares would, over the same period, have produced a total return of 97.92%, giving a CAGR of 4.36%, and including at least one draw-down exceeding 50%. It seems that the U.S. dollar, at least, produces trends that are comparable to those produced by the stock market. A fairer comparison though, would be to compare the S&P 500 index’s results applying the same trend-following strategy.
The result is a total return of 50.11%, giving a CAGR of 2.57%, with a worst draw-down of 36.24%, producing a profit factor of 1.38. It must be admitted that this compares favorably to the Forex results, as the CAGR is higher than most of the currency pairs, but more importantly, the maximum draw-down is relatively low. It beats everything except the GBP/USD currency pair.
The strongly negative performance and unusual behavior of the Swiss franc (CHF) is a notable standout feature of this Forex universe. It is not merely a failure to trend, it is a strong propensity to revert to a mean. Although I do not include the data here, excepting the Euro crosses, the currency crosses (non-USD pairings) have not trended well in recent years. This should be a warning to Forex trend traders, as how can we know that the same pairs that have trended well in the past will continue to trend in the future, particularly when stock indices do seem to trend well, particularly on the long side? Here are the results of the same test applied to the S&P 500index “long only”:
The result is a total return of 53.97%, giving a slightly CAGR of 2.73%, but a significantly improved worst draw-down of 18.78%. This is superior to every currency pair except the GBP/USD, and per trade, it is better even than that, because it spent more time out of the market, and is therefore superior on a risk-adjusted basis. The profit factor of 2.87 is impressive.
Which Forex Pairs Will Trend the Most?
As mentioned previously, it might be dangerous to assume that the USD pairs will continue to trend most strongly in the future. However, as the USD is the primary global reserve currency, and is a counterparty in approximately 80% of all Forex trades by volume, it seems likely that its propensity to trend has basis in market structure, at least for as long as it continues as the dominant global currency. This argument is backed up by the fact that the Euro also accounts for a lot of market volume, and is the second currency most prone to trending behavior. Technical approaches such as selecting the most strongly trending Forex pairs have not produced notably better results (except in EUR/USD and USD/JPY), so there seems no alternative to applying some type of discretionary or market/fundamental logic.
Trending Behavior of Popular Commodities
These days, most Forex brokers offer trading in a selection of commodities, most typically gold, silver, and crude oil, and possibly a few others. How do these assets look after the same analysis is conducted of their historical behaviors? Here I am only using data up to 2014, not 2017 as in the previous analyses.
The results for crude oil and gold are attractive and compare well to the best-performing Forex currency pairs which we looked at earlier. If these commodities are taken together, a CAGR of 8.48% would have been produced from a total return of 200%, with a worst draw-down of 138.52%.
A wide universe of the seven major global currencies has not shown a statistical propensity to trend. However, the largest global currencies such as the U.S. dollar and euro have done so.
The persistence of Forex trends in the USD pairs has been barely positive over the past 9 years.
The major U.S. stock index the S&P 500 has shown a strong propensity to trend with minimal draw-down, making it arguably the most attractive trend trade of the past 20 years and perhaps longer. The long-only analysis produced an extremely large profit factor of 2.87, beaten only by GBP/USD within the entire universe analyzed within this article.
Major commodities have produced trends similar to those exhibited by the U.S. dollar Forex currency pairs, with similar overall profit factors.
I suggest the assets covered here can be most usefully broken down into two categories: the U.S. dollar against currencies and major commodities, and the U.S. stock market.