Reader Bob has been following the trend tracking principles for a number of years. Here’s what he had to say:
I have followed your Trend Tracking method for several years. It seems that trends are getting compacted into shorter time periods. Thus I end up with “Buy-In Vulnerability.”
By that I mean: If I buy Fund A at $10.00 per share, it must steadily gain, to at least $10.75 to overcome the 7% Sell-Stop point.
In February, I got stopped out of two funds when the market turned sour, with 3 consecutive days of triple digit losses. Immediately after it started its upward climb, and I was sitting on the sidelines.
This was primarily due to the funds not gaining enough to overcome the 7% Sell-Stop level, and my wanting to preserve what little profit I had made before the big downturn.
Yes, being on the back side of this current credit bust can affect the trends in that they appear to have shorter durations than ever before.
A buy signal followed by a sell within a short period of time will always cause a small loss or a break even at best. It appears from your email that successfully avoided the 2008 market drop, which puts you way ahead of most investors, including professionals.
The best time to establish a new position is at the moment the price and trend lines of the TTI cross, and we move into bullish territory. That happened on June 3, 2009 for the domestic arena. Let’s look at an example.
At that time, I purchased QQQQ for some clients, which proceeded to move higher based on the general trend of the market. Early in February 2010, we experienced a sharp pull back and got stopped out of that position. Take a look at the 1-year chart for QQQQ:
You could not have scripted a better scenario for following trends. The left arrow shows our approximate entry point, while the middle arrow shows the point when our stop loss got triggered and moved us to the sidelines.
Since this trend lasted almost 8 months, we gained over 17%. Our basis for that sell stop point (the high reached) was 46.59, which got taken out in early March 2010 (right arrow) and would have offered a new opportunity for re-entry at that time. Last Friday, QQQQ closed at 49.03, which represents a nice gain for the re-entry period.
Again, if you are late to the party by allocating while the uptrend is in full swing, you risk a potential whipsaw, and a smaller profit, which is simply part of trend tracking.
I am not sure when you entered the market and experienced the Buy-In Vulnerability you described, but it does happen. While fund selection is critical, a little luck from time to time does not hurt either.
It would be interesting to know when exactly you bought the funds you were stopped out of in February. As you can see from the above example, we need to be in the market at least 6 months to overcome the sell stop level and sell at a profit.
Again, keep in mind that this is not an exact science, but merely a method to keep your portfolio safe when the bear strikes. Despite its shortcomings, my preference is to be on the sidelines at the appropriate time in order not to watch my portfolio get clobbered at a 50% rate.
Disclosure: We currently have positions in QQQQ.
Comments 1
Ulli,
Thanks for all your work. I have expressed my views earlier but I will just repeat them. Trend tracking is excellent method of investing particularly when investing is not your primary job function.
Having said that I feel that you don't follow your own method. It would work much better to follow the long term trend instead of the stop loss at 7%.
According to your charts, the long term trend hardly reverses more than once a year. But during the same time, there are several 7% or more dips. I have three issues with trading on that:
1) You have to babysit it every day
2) You lose money on every 7% dip
3) You transact too many times which prohibits investing in some funds.
You have already said that your clients would not like their profits vanish if you went purely by trends instead of 7% dip rule. I think this is more of educating them by historical examples of which method ultimately works better.