How Trend Trading Outperforms Buy and Hold in Canada's Marijuana Sector!

In a previous blog post, I introduced the notion of investment bias and discussed how our biases can prevent us from investing when the chart is telling us to be invested and can also prevent us from stepping away from an investment when the chart is telling us to sell. One sector where investors biases have perhaps kept them invested beyond what technically makes sense is Canada’s Marijuana sector.

While many investors have enjoyed the ride up, there are just as many now wondering what has recently been happening in the much-hyped pot sector. When we look at how the big names have been performing recently, we can see that Canopy Growth (WEED) is down 31% from its all-time highs, while Aurora Cannabis (ACB) is down 37%. Others have fared worse, with Aphria (APHA) down 63% from all-time highs and Nasdaq darling Tilray (TLRY) down 84% from its peak price. The Horizon Marijuana Life Sciences Index ETF (HMMJ), which perhaps provides the best snapshot of the entire industry is down 32% from its all-time highs.

While there may be many fundamental reasons for the recent pull-back, I won’t get into discussing those here. Instead, I will illustrate how giving back these gains could have been avoided by using a simple trend trading strategy. Using data from Free Stock Charts, I examined the concept of using several daily moving averages (20, 30, 40, and 50) as buy and sell signals when investing in the marijuana sector ETF (HMMJ). The signal used is that if the closing price of the ETF is above the specified moving average, investors remain invested in the ETF. If the closing price drops below the moving average, investors sell the ETF and sit in cash until another buy signal triggers. For each moving average, I back-tested this for the duration of the life of the ETF (from mid 2017 until present) and then compared the investment results to the buy and hold case. The results are illustrated below.

We can see that in the buy and hold case, an initial investment of $1000 returned 120% over two years, which is a very nice return over that time period. This is similar to the 50-day moving average case, which returned 133% over the same two-year period. Unfortunately for buy and hold investors, this is where the similarities end, as we can see that the 40, 30, and 20 day moving average systems return 230%, 265%, and 333%, respectively. While it is evident that the 50 MA signal is too slow in responding to the volatility in the ETF, the progressively shorter MA’s become more effective as timing signals, drastically outperforming the buy and hold investment in each case.

Employing a trend trading strategy like the one examined here can help investors identify critical turning points and avoid giving back their hard-earned gains. Many investors are now wondering when the marijuana sector will begin to trend upwards again. The chart below shows the current status of the market in the context of our high-performing 20 MA and indicates why investors should remain on the sidelines for the time-being.

Trend trading strategies have been out-performing the markets for decades and are employed by some of the worlds most successful hedge funds, yet we are told that timing the market is too difficult for ordinary retail investors. This analysis suggests that trend trending can be accessible to anyone and is an important way to maximize gains while simultaneously minimizing risk.

www.investthetrend.com