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Market Statistics, Trend following

Systematic Stock Index Trend Followers Are An Easy Prey

The dynamics of stock indices have changed notably since the fall of 2008. Trend volatility has increased substantially. Systematic trend followers, i.e. fund managers and traders who employ mechanical systems that attempt to follow the trend have been unable to profit for the most part. The winners are strong hands and long-term investors. Some have to lose for some others to make money, especially during times when not only new wealth is not created but old wealth is being destroyed.

On the monthly chart of S&P 500 index below it may be seen that the average magnitude of a trend correction after 2009 is larger than that of the 2003-2007 period:

It may be also noticed that for most of the duration of the 2003-2007 uptrend, the 6-month Average True Range (ATR), expressed as a percentage of closing price, stayed below the horizontal red line at 5.4%. On the other hand, the same indicator has stayed well above the same line after that point, as a result of the increased trend volatility.

The increased magnitude of trend corrections after 2009 has made the life of trend followers, especially of systematic ones, extremely difficult. This fact, coupled with choppiness has resulted in wealth transfer from those who still believe that they can put a few lagging indicators on a chart, or program them in a computer, and make substantial gains to those that move size at will and essentially fade those who rely on techniques of the past century to profit.

To be more specific, the time that stock index trend following could be accomplished with a lower win rate in the range of 35% to 45% is over and I do not think it is coming back, at least for equity indices. Choppiness and trend corrections with magnitude above past averages lead to losses when there is a low win rate. This can be also shown mathematically and the proof is in this post.

I believe that the same dynamics are emerging in most markets, making it extremely hard for naive trend-following techniques to profit. These type of techniques arean easy prey nowadays for strong hands and automated bots in flocking mode. Only very short-term traders have a chance against the various types of  predators that are dominating the markets.

Disclosure: no relevant position at the time of this post and no plans to initiate any positions within the next 72 hours.. 

Charting program: Amibroker (Charts created with AmiBroker – advanced charting and technical analysis software.”) 


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