Market prices move in trends and traders can make, and more
importantly, keep large profits if they are on the right side of
the trend. Keeping profits requires investors to move out of
markets that are falling and switch tocash or take short positions
that can benefit from declines. The importance of avoiding large
losses is obvious after thebear market that began in 2008 when many
investors lost 50% or more of their account value.
A simple trading strategy of following the 10-monthmoving
) would have helped traders avoid almost all of the losses in that
bear market. When using an MA trading strategy, traders buy when
the price closes above the MA and sell when the price moves below
the MA. On
, this strategy delivered a sell signal less than 8% below the
market top in 2007.
The long-term success of the 10-month MA has been well
documented in Mebane Faber's The Ivy Portfolio and several other
papers by the technician. Over the long term, being in thestock
market orbonds , or nearly any otherinvestment , only when the
price is above the 10-month MA would have beaten the results
achieved by abuy-and-hold investor. This is because priceswill be
above a MA when they are trending higher and below the MA in
downtrends. When looking at results for periods of 30 years or
more, trend following indicators will almost always be
In the chart of SPY shown above, one of the problems with trend
following strategies can also be seen. After the bear market, the
buy signal was given at the end of June 2009 and traders would have
bought SPY nearly four months after the bottom was reached and
after prices had already moved up by 37%. Delayed entry signals
like this can cause the system to lag buy-and-hold returns inbull
Because of late entries at the bottom andwhipsaw trades that can
occur as the trend is changing, this strategy canunderperform
buy-and-holdinvestments over a period of years. In fact,
outperformance and underperformance seem to alternate over
different time frames.
From the beginning of 2000 through the end of 2012, traders
using the 10-month MA to time long trades in SPY would have more
than doubled theirmoney while a buy-and-hold investor would have
seen their account grow by only 51%. But since 2009, traders
relying on the MA strategy would have seen a gain of about 29%,
less than half the 64% gain of the buy-and-hold investor.
One of the biggest benefits of the 10-month MA might be the way
that it reduces risk. Since 2000, a buy-and-hold investor in SPY
would have lost as much as 51% of their account balance. The
steepest loss for a trader following all of the MA sell signals
would have been about two-thirds less, or 16.6%.
Similar results are seen when testing
PowerShares QQQ (Nasdaq: QQQ)
. ThisETF ended the year 28% below its January 2000 price and was
more than 81% from its all-time high. Traders following a simple
10-month MA have a gain of about 45% and never showed a loss of
more than 26%. But since 2009, the buy-and-hold investor has beaten
At the end of 2012, the 10-month MA was warning traders that the
next year could bring lower prices in QQQ. That ETF ended the year
about 1% below its 10-month MA. SPY was above its MA but momentum
had turned negative and thestochastics indicator was on a sell
One brightspot in the market is small caps.
iShares Russell 2000 Index (
is leading the market into the New Year.
The 10-month MA is an indicator that can be used to define the
trend in the price of any market. For now, it is warning traders to
avoid QQQ, which is also on astochastics sell signal. Other
are still in uptrends but are showing signs that momentum is
overbought and slowing.
Traders looking at committing newfunds to the stock market
should limit their buys to small caps, which are in an uptrend
Action to take -->
Avoid new investments in QQQ and large caps. Buy IWM and
small-capstocks as long as the chart remains bullish.
This article originally appeared on ProfitableTrading.com:
Indicator Points to Caution in 2013… Except for
This Sector of the Market