Tuesday, February 3, 2015

Trend Model Jan 2015 report card: +1.9% in a tough market

This is the latest performance update on my long-short account based on my Trend Model signals (see An intriguing Trend Model interim report card). The Trend Model account had another excellent month as it was up 1.9% in January; the one-year return was 45.90%; and the return from inception of September 30, 2013 was 42.7%.

I reiterate my disclaimer that I have nothing to sell anyone right now. I am not currently in a position to manage anyone`s money based on the investment strategy that I am describing.

Trend Model description
For readers who are unfamiliar with my Trend Model, it is a market timing, or asset allocation, model which uses trend following techniques as applied to commodity and global stock market prices to generates a composite Risk-On/Risk-Off signal (risk-on, risk-off or neutral). I have begun updating readers on the Trend Model signals on a weekly basis (for the last weekly comment, see A correction is brewing) and via Twitter @humblestudent as new developments occur.

The chart below shows the actual (not back-tested) changes in the direction of the signal, which are indicated by the arrows, overlaid on top of a chart of the SP 500. You can think of the blue up arrows, which occurred when the trend signal changed from negative to positive, as buy signals and the red down arrows, which occurred when the trend signal changed from positive to negative, as sell signals.

Trend Model Signal History

A proof of concept
While the results from the above chart representing paper trading is always interesting, there is no substitute for actual performance. As a proof of concept, I started to manage a small account that traded long, inverse and leveraged ETFs on the major US market averages and, on occasion, sector and industry ETFs. Trading decisions were based on Trend Model signals combined with some short-term sentiment indicators. The inception date of the account was September 30, 2013 and the chart below represents an interim report card of that account. (For more details on how the Trend Model or how the account is managed, see my post Trend Model FAQ).

When evaluating the performance of this trading account, keep in mind that this is intended to be an absolute return vehicle. While I do show the SPY total return, which includes re-invested dividends, for illustrative purposes, the SP 500 is not an appropriate benchmark for measuring the performance of this modeling technique.

A challenging January
The account was up 1.9% in January, 45.9% for one year and 42.7% from inception (September 2013). However, I would also like to point out that turnover averaged about 200% per month, so this strategy is not for everyone.

Despite the positive returns shown by the account, the market environment was especially challenging for this kind of trading system. The Trend Model signals are primarily based on the application of trend following principles to global stock and commodity markets. Trend following systems simply do not perform well in either sideways markets that are subject to whipsaw, or markets that experience sharp reversals.

As shown by the chart of the SPX below, January was a seriously up and down whipsaw market. The account achieved positive returns largely from the use of short-term sentiment trading models that are used to supplement the main Trend Model signals.

Despite the challenging environment, this strategy continue to be promising:
  • Returns are strong and the Trend Model is performing better than expected.
  • Returns are highly diversifying compared to major asset classes. They are uncorrelated with equities (correlation of -0.19 with SPY) and bonds (-0.19 with AGG).
  • Returns are consistently positive, with a 75% batting average.
Despite the positive return shown by the account in January, I would not expect that the string of positive months will continue should the market continue to be choppy in the months ahead. The short-term sentiment models are performing well in the current environment, but I have observed that their signal-to-noise ratio tends to be lower than the main trend following model.

2015 could be an acid test year
I continue to believe that the market environment is likely to be challenging for both stocks and the Trend Model trading strategy in 2015. In a recent market review, I postulated a positive year for US stock prices but with a much higher (see 2015: Bullish skies with scattered periods of volatility). Trend following models do not perform well in choppy markets.

The stock market does see increased volatility, then the choppiness will indeed be an acid test for this trend following strategy. Positive returns during these volatile periods will lean more on the short-term sentiment models that I use to better assist the main trend following model to calibrate both entry and exits as well as the magnitude of position commitment.

To summarize, results continue to be promising for this model. Readers who want to monitor the signals of the Trend Model to subscribe to my blog posts here, which include Trend Model updates, or follow me via Twitter @humblestudent.

1 comment:

JP1776 said...

This is the timeline of your Trend Model signals. I don't see that reflected in the History shown in this article:

Finger poised no more on the "sell" button http://stks.co/b1QaHCam Hui, CFA @HumbleStudent · Dec 29
Finger poised no more on the "sell" button http://stks.co/b1QaH I sold today and went to cash.
I sold today and went to cash.

The adults are back at their desks. Sell?
Trend Model signal summary
Trend Model signal: Neutral (downgrade)
Trading model: Bearish (downgrade)

A consideration of the bear case
Trend Model signal summary
Trend Model signal: Neutral
Trading model: Bullish (upgrade)

A correction is brewing
Trend Model signal summary
Trend Model signal: Risk-off
Trading model: Bearish (downgrade)