If it doesn't reveal too much I would be interested in knowing what technicals you look at to determine when an ETF is trending. How do you determine sector allocation percentages? Thanks for sharing
I don't believe knowing the past trend offers any edge in entry. only after your in, does a trend matter, or exist relative to the position.
HuggieBear, I have backtested the system showing a max drawdown of almost 35%. I'd rather not comment on returns at this point... Thanks for the question... Boston
In2Deep, Not a problem. May I ask you to read this post first? http://myhedgedfund.typepad.com/my-hedged-fund/2010/12/investment-strategy.html#tp I'll certainly answer any questions you may have after that introduction. Best, Boston
I have spent a lot of time backtesting trend following strategies on ETFs, and I'm currently actively trading one myself. One of the things I've found consistently is that returns are lower and risk is higher when using smaller positions across a much larger set of instruments. I think there are a couple of reasons for this. First, everything seems to be correlated to a much larger degree than one would hope. So, even though you have 30 2.5% positions, the high correlation leaves you with as much downside risk Second, and this is the trickier part, when I use a more concentrated approach, the system tends to find the "long lived" trends and runs with them. This has the effect of locking up a good chunk of your capital in these major trending instruments with a great return, and thereby bypasses a lot of churning signals in the meantime. In other words, I've found it pays off to take a bigger shot and try to catch the very long-lived trends. That's where my systems tend to get their biggest payoff. In your case, you will obviously catch those trends, but it will be such a small part of your portfolio that the impact won't be that significant. Anyway, this was just an interesting phenomenon that I encountered, as I kept trying to diversify more broadly with smaller positions and kept getting worse results. It seemed like i ended up with the same downside risk but without the big winners I got in a more concentrated approach.
Yes, my experience agrees with your statement regarding returns, although not quite on risk, meaning, by concentrating positions (which happens for me over time as I add blocks to existing positions) I tend to experience higher returns but with higher risk. Also of interest, the high correlation that you reference does result in me having several positions in similar instruments. For example, the current energy trend has me invested in Energy, Natural Gas Exploration, Nuclear Energy, Russia and Canada which are of course very strongly correlated. I could argue that the high correlation results in the bigger position in a single vehicle that you reference, but it does come at a higher transactional cost. May I ask about the maximum number of instruments you trade at a time? Thanks for your quality post. Boston
I have been running my system against about 20-30 ETFs, mostly country specific with a few commodity specific. I backtested the system against a more limited set of ETFs, due to the fact that many country specific and commodity ETFs have more limited history. I expanded the number of ETFs I trade against, assuming that the basic strategy would be solid against any instrument. My system is fairly "long", in that it can follow trends for a couple of months up to a couple of years. What i've found in practice is I've gotten killed on some of the newer ETFs i've introduced, as they have much higher volatility and no effective way to hedge. Anyway, recently i decided to go for a much more concentrated approach. I am focusing on just 10-15 ETFs, and only the big diversified ones or those from large economies. I trade with much larger position sizes, but won't risk more than 2% on any given position. So instead of trading the individual emerging market economies, i will just trade EEM with a much larger position size. I think this is going to work out better in the long run. It's actually easier, in my mind, to manage total correlated risk by using fewer, but broader, instruments. Of course, this could be very specific to my system, which is truly a long term trend following system. If you are running something that tries to pick up trends for less than 30 days, I can imagine a different approach would be appropriate.
By the way, I am only shooting for a CAGR of 20% - 30%, with drawdowns in the same range. While this would be a stellar return, it is more reasonably achievable with an actively managed but longer term trading approach. If i were trying for higher returns I would need to hit more signals on shorter timeframes with more frequent turnover...
Thanks for your reply. But doesn't an existing trend have a higher probablity to continue than to cease to continue?
Week 10: Well, it was just "The Quiet Before the Storm...." Funny how the market changes from week to week. It was only last week when I wrote about how it had been a quiet week for The Fund from a trading perspective, selling only one position in Week 9. This week (Week 10) the market sold heavily, and it triggered my selling or reducing of 14 positions. I am at week's end holding over 70% cash and returns are basically back to where they were at the beginning of the year; more on that shortly. Before I get into the specifics though, let me write a couple of sentences on what I consider to be one of the greatest advantages of following trends. Fluctuations such as the ones we witnessed this week would have in the past created some anxiety for me, and I suspect the same would have happened for some of the readers. Trading based on fundamentals would have caused me to question my analysis, my decisions and maybe even the data which led to those decisions. Was my analysis correct? Did I miss anything? Was the decision the correct one based on the analysis? But wait... Was the data which I used in the analysis accurate? What if someone is "cooking the books?" Or what if they are misleading us? Does someone have access to information that I don't (well of course)? It was interesting to me how relaxed and calm I was the entire week. I followed the system's signals to a "T." I sold what I needed to sell, when I needed to sell it... with absolute trust in the system. With trend-following, stages like these feel detached, unemotional... or at least with the range of emotions you feel when watching a movie. We may have some interest in the characters and the story, but the fact that we have a good sense of how the movie will end reduces the full range of emotions. The fact that "Trend-Following" as a practice allows for a reduced spectrum of emotions cannot in my opinion be overstated. Transactions for the week As previously stated, a fairly active week: - Sold positions in Copper (JJC), Grains (JJG), Semiconductors (SOXL), Technology (TYH), Timber (CUT), Japan (EWJ), Financial Services (FAS), Nasdaq (TQQQ) and Metals and Mining (XME) - Reduced positions in Energy (ERX), Canada (EWC), Natural Gas Exploration (FCG), Nuclear (NLR) and Oil & Gas Exploration (XOP) A good number of these positions (particularly Semiconductors and Financial Services), exhibited the well known "whipsaw" characteristics common in many TF systems. I bought (or added to existing positions) as the trend hit certain indicators, only to see it quickly reverse in a short amount of time. In situations like these we just shrug our shoulders and move on. Performance for the year is now basically flat (-0.15%). Charts with weekly performance and benchmarks follow: Current sector allocation breakout: Specific holdings in more detail can be seen here. What Next Week May Bring: The reader may have noticed that I retain some energy positions, I would not be surprised if I receive buy signals in energy stocks this week, the trends in the sector remain solid. The same could be said for Commodities and the broad market S&P 500; I may buy there at some point this week. I also remain keenly aware of the developing opportunities in the short side, several developing country ETF's (Indonesia, Vietnam, Turkey) have shorting potential at some point. Questions as always welcomed... Happy Birthday to me! Boston