3 Buy Signals for Trend Followers

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Jan 30th, 2013 | By | Category: Featured, Investor Education, Trend Playbook, Trends

There are no two ways about it: The buy signals are flashing for trend followers right now.

For the past few months, I’ve been telling you about an approach to investing called “trend following.” It’s a method of investing based on using hard rules to jump onboard emerging trends — and to ride them as they play out. I’ve already shown you how a simple trend-following approach can pull some enormous profits out of the market.

Today, I want to show you what our trend-following model is telling you to buy…

As a refresher, I introduced a trend-following model to you a few months ago. It uses a 300-day moving average to identify big trends in the market. And going back awhile, it’s turned out some stellar performance compared with the tired strategy of buy-and-hold investing.

Here’s a comparison of how our trend-following model (the orange line) has fared against the S&P 500 (the white line) since the beginning of 2008, one of the toughest periods investors have ever seen:

While buying and holding stocks would have returned 8.6% over that period, trend following earned gains of 50.5%. That’s some material outperformance.

Before we get into what signals our system is spitting out right now, let’s look at a reader question from last week:

“You discuss the S&P 500 as it relates to its 300-day [moving average]. You say, ‘This is a hands-off system. It trades only once a month’ I am not sure what you mean when you say it trades only once a month — can you elaborate on this comment?”

When I say that our system trades only once a month, I mean that our performance is based on running the system and taking trading signals only once every month.

Remember, because of the length of the moving average we’re using, our system works best at spotting longer-term trends. For that reason, trading more than once a month can pull too many false signals out of the market — and eat away at your potential returns.

And that’s great! If the system works, who wants to trade more than once a month anyway?

One thing that’s important to remember about trading using a math-driven trend-following system is that you don’t want to overanalyze your trading signals. The heavy analysis comes into play when you’re developing your system, not when you’re trading it. If the statistics and back testing indicate that your system works, then that’s when you take your hands off and start listening.

By its nature, a trend-following approach is going to spit out trading signals that you won’t want to follow from an emotional standpoint. If you want to be successful, it’s critical to blindly follow the system…

So what’s our system spitting out right now? Let’s look at the big picture by splitting up buy signals into big-picture asset classes:

The Buy List: For starters, it likes stocks. U.S. stocks have been rallying hard for the last six months and change, and at this point there’s a lot of distance between the S&P 500 and its moving average. Until that trend reverses, that means that trend followers should own big market indexes.

It’s not just U.S. stocks, though. International stocks are signaling a buy here too — an even stronger one than we’re seeing in the S&P 500. That’s not hugely surprising. Foreign equity markets in places like Shanghai, Japan, India and even Europe are all looking very bullish from a technical standpoint.

The third — and strongest — buy signal comes from real estate investment trusts, or REITs. REITs are a great low-correlation asset class because historically they tend to move less in step with regular stocks than almost anything else. With real estate values climbing worldwide, these REITs are enjoying appreciating assets on their balance sheets as well as increased dividend payouts for investors. So the buy signal is still intact on this group of investments too.

The Hold List: Commodities look less exciting right now. Both gold and oil have been consolidating sideways for much of the last year, so even though there may be some technical strength heating up in both, neither is sending a buy signal through our model at the moment.

That’s probably not a huge surprise for investors who’ve been watching commodity prices closely — but there are plenty of emotional appeals that make hard assets look tempting. Our model is telling us to ignore them for now. The sideways action in commodities is a good example of why we stick with an infrequent monthly trading signal; with prices moving in a sideways range right by the 300-day moving average, we’d be getting a lot of false signals if we had a more frequent trading program.

One Strong Sell: While commodities aren’t looking bullish yet, they’re at least close to buy signals in the future. One asset class conspicuously isn’t: Treasuries. Treasuries broke the multiyear uptrend that’s been in force since the Great Recession scared investors away from stocks, and now we see money coming out of those Treasuries as a big potential catalyst to keep the stock rally moving higher.

Ultimately, that analysis doesn’t matter a whole lot. Our trend-following system says to stay away, so we will…

Happy trading,
Jonas Elmerraji, CMT

Author Image for Jonas Elmerraji

Jonas Elmerraji

Jonas Elmerraji, CMT, is the co-editor of STORM Signals and Penny Stock Fortunes, and a contributor to Agora Financial’s Trend Playbook. Jonas got his start on the fundamental side of the market, poring over financial statements and valuations to find sound investments – today, he specializes in blending fundamental and technical analysis. Jonas is a senior contributor to TheStreet.com, and has been featured as an investment expert in Forbes, Investors Business Daily, and CNBC.com among others. 

Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation.

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