Trading a Directionless Market

Gil Morales and Chris Kacher
Posted: Jan 23, 2012 12:01 AM

In this challenging, trendless environment that has persisted for about a year, trends still occur even in these highly unusual times and price/volume continues to work, though it is true that many models have been knocked out of the picture since price/volume interpretation has become that much more challenging in the last few years. Michael Covel wrote the excellent book "Trend Following" which contains in-depth interviews with successful long-time trend followers John Henry, Bill Dunn, and Ed Seykota. And yes, while such noted trend followers have been encountering difficulty, they are no stranger to steep drawdowns, and in their 25+ year careers, have always more than recovered, thus maintaining the integrity of their long term track records.

In terms of our own performance, we focus on reporting in real-time on potentially winning names that can be pyramided as they move higher though such names have been few and far between since such quality trends have been very rare over the past year. At the same time, our Market Direction Model (MDM) focuses on capturing intermediate term trends, whether up or down, in the general market. So while high frequency trading may derail some day trading activities, we have managed to weather the HFT storm. Our pyramiding of precious metals and a few select names in 2011 made all the difference, thus we were able to finish 2011 up +24% while the trend following wizards collectively finished 2011 down, with a number of wizards down double digit percentages: and the state of trend following shown here:

And with that said, some members outperformed our +24% return as they tended to trade 3-times ETFs more aggressively or pyramided names we did not. Some simply invested in leveraged ETFs, thus were able to realize returns such as reported in our tables, such as TYH at 35% or even higher returns using TVIX, though TVIX, as we have warned, is not for the faint of heart. With high rewards come higher risks, so always position size according to your risk tolerance levels.

Incidentally, over many market cycles, there have been periods where trend following and price/volume action were declared dead but what makes traders successful over the long term such as the trend following wizards is that they continue to apply their systems through thick and thin, withstanding steep drawdowns of over 50% in some rare cases, knowing the markets will always trend again.

Thus, our service can become even more valuable during these "scare 'em and wear 'em out" markets, when profits not only run dry but drawdowns are frequent. While the vast majority of members have stayed with us, and new members continue to join, there have been a scant few that have thrown in the towel with the intention of returning when conditions improve. While this is understandable, the only issue is that new trends often begin when least expected. And the other risk is that one may take their eye off the markets, only to miss out on big profit opportunities when they do arise, whether it is in the form of pyramiding a winning stock, shorting a stock that plummets, or profiting from a true call issued by the Market Direction Model.

That said, with the advent of dark pools, high frequency trading (HFT), and the like, a few rightly question whether price/volume action and trend following are still applicable. Over the last century, whenever there was a big change to infrastructure, such as the advent of radio and television to disseminate news, the move from 1/8 to 1/16 spreads, or the move to decimalization, such moves have spurred questions about the viability of trend following and price/volume action. Yes, markets did change, but the overriding principles remained sound. Thus, based on our results in 2011, our answer is a resounding yes that price/volume action and trend following are still applicable.

So far, the uptrend in 2012 has been on low volume.  Leaders are acting better but only slightly. While institutions can create large footprints of high volume, they also take note of high volume which can lead to a further and faster continuation of the trend. The current uptrend is weak. The model is looking for any confirmation of this weak uptrend by way of a follow through day supported by sound action in leading stocks.

Here's to a 2012 that potentially marks a return to trending markets.