A Profit Chart You Won’t Believe

Start your Free Tomorrow In Review Preview - Sign Up Here:

Sep 21st, 2012 | By | Category: Featured, Trend Playbook, Trends
leadimage

“The four most expensive words in the English language are, ‘This time it’s different.’”

– Sir John Templeton

“This time it’s different”. “The new normal”. There are plenty of clichés floating around the investment world right now as money managers try to explain what’s going on in the market.

That’s not really surprising. After all, professional investors need some sort of excuse when they lose money – and in absolute terms, investment managers lost more of their clients’ money in 2008 than ever before. But is this post-crash market really different? Not a chance.

And in fact, one long-term strategy actually gave investors the chance to make millions of dollars in 2008 as everyone else was getting shellacked. Today, I’d like to share more details with you…

Last week, I showed you why the tried and true “buy and hold” approach isn’t really what most investors think it is. And I told you about trend following, an approach to investing that focuses on riding the market’s biggest trends to substantial gains. If you missed it, you can catch up here.

When it comes to a new investment strategy, I realize that the proof is in the pudding. That’s why I want to show you how a simple trend following system would have fared through 2008′s catastrophic market. I’ll even show you how you can put that strategy to work for your portfolio today…

 

A Simple Trend Following Approach

For trend followers, there are basically two steps to figuring out what to buy: identifying when a trend begins and identifying when a trend ends. To do that, we don’t rely on emotion or opinion – instead, it’s critical to base any investment decisions on a set-in-stone system. Today, we’ll construct a quick one.

If you’re familiar with technical analysis at all, you’ve probably heard of a moving average. In short, it’s the average price of a stock over a set number of days. A moving average is a stellar indicator of trend – if it’s moving steadily higher, then we know that a stock is generally moving higher over the time period that we’ve set. More importantly, we can define moving averages mathematically, so, we’ll go ahead and use a moving average as our “trend indicator”.

For simplicity’s sake, we’ll apply it to just one investment: the SPDR S&P 500 ETF (NYSE:SPY).

So let’s create a quick rule. If SPY moves above the 300-day moving average (a long-term average that approximates a year’s worth of price data), we’ll buy. If it falls below the 300-day, we’ll sell. In real terms, that rule says that if SPY moves above the 300-day moving average, Mr. Market is entering an uptrend, and if it moves below, it’s entering a downtrend.

So, how would that simple strategy have fared over the last fifteen years? The chart below shows all of the times that the system would have traded and what your profits would have looked like:

All told, you’d end up with gains of 74.3% — nearly double the 40% and change that a buy and hold approach would have earned you. But look at the white chart below of your profits. It tells an even more exciting story.

See the handful of flat lines over that period? Those are the times you’re out of the market because the system said “sell”. So you didn’t touch stocks for almost 2 years while the tech bubble was bursting, and you were out of the market for all of 2008! I think you can see just how dramatically this system reduced the risks of being an investor.

But despite that “hands off” approach to investing, you still beat the market by a wide margin.

Remember, the rules we just made up are crude. By adding some extra simple short selling rules to the approach, our trend following system could have upped its total profits to 80.8%, and actually made substantial profits when the floor was falling out for everyone else in 2008.

Our crude trend following system produced a chart that’s hard to believe, especially when you consider the fact that it includes two of the biggest market crashes in most investors’ memories. There’s a lot an investor can do to improve performance beyond what I’ve showed you – adding individual stocks, more complex rules, or introducing statistical optimization are all things that can easily improve returns under a trend following system.

But the key here is that following trends (and not trying to predict them) holds the keys to some incredible returns while smashing risks much lower than you’d see from a “buy and hold” approach.

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.

Start your free Tomorrow in Review email subscription...

  

We Will Not Share Your Email Address
We Value Your Privacy

Tags: , , , ,
ShareThis
Print This Post Print This Post

13 comments
Leave a comment »

  1. [...] First off, if you haven’t had a chance to read last week’s article, I’d strongly recommend taking a look to get up to speed on trend following. You can find it here. [...]

  2. Why did you pick 300 day moving average? I remember reading a book many years ago that said the same thing for 200 moving averages. I’m curious if you back tested several values and choose 300 from your tests.

  3. Dear Sir: I am looking for some face to face conversation and guidance with my portfolio (c. $150.K total). Does Agora Financial offer this service? Robert Boone, College Park, MD

  4. Hello There. I found your blog using msn. This is a very
    well written article. I will make sure to bookmark it
    and return to read more of your useful information. Thanks for the
    post. I’ll certainly return.

  5. Good post. I learn something totally new and challenging on blogs I stumbleupon on a daily
    basis. It’s always interesting to read content from other writers and practice a little something from their web sites.

  6. I rarely create remarks, however after browsing some of the responses on
    A Profit Chart You Won’t Believe. I do have 2 questions for you if you tend not to mind. Could it be simply me or do some of these responses look as if they are coming from brain dead folks? :-P And, if you are posting on other online social sites, I would like to keep up with you. Would you make a list of the complete urls of your social community pages like your Facebook page, twitter feed, or linkedin profile?

  7. I’m not sure why but this blog is loading very slow for me. Is anyone else having this problem or is it a issue on my end? I’ll check back later
    on and see if the problem still exists.

  8. I don’t even know the way I stopped up here, however I thought this publish was great. I don’t recognize who
    you might be however certainly you’re going to a famous blogger should you aren’t already.
    Cheers!

  9. Great site you have here.. It’s difficult to find high-quality writing like yours
    these days. I really appreciate individuals like you!
    Take care!!

  10. What’s up, its pleasant piece of writing on the topic of media print,
    we all know media is a great source of data.

  11. Glucomannan discovered in clinislim is really a soluble
    fiber that is capable of absorbing h2o present in the digestive system thus types a jelly like texture.

    Pay for your gym membership in advance to make sure you utilize it.
    In addition, individuals who obtained more than enough
    HCA in Garcinia Cambogia sorts noticed a lessen in LDL and triglyceride degrees as
    well.

  12. I almost never drop responses, but i did a few searching and wound up
    here A Profit Chart You Won\’t Believe. And I do have
    2 questions for you if it\’s allright. Could it be just me or does it appear like some of these comments
    appear like they are coming from brain dead
    people? :-P And, if you are posting on additional places, I\’d
    like to follow anything fresh you have to post. Could you
    make a list of all of your community pages like your linkedin profile,
    Facebook page or twitter feed?

  13. I’m not that much of a internet reader to be honest but your sites really
    nice, keep it up! I’ll go ahead and bookmark your website to come
    back later on. Cheers

Leave Comment

By submitting your comment you agree to adhere to our comment policy.