The objective of trend trading is to buy a stock or ETF when a positive trend is beginning and then sell it when it shows signs of ending. By investing only in positive trends, the investor is able to side-step market corrections and avoid the inevitable draw down of capital that occurs during a bear market. Moving averages are often used by trend investors to indicate when a trend is beginning and when it is ending. Consider the chart below.
In this example a positive trend begins when the closing price crosses above the specified moving average (blue line), thus generating a buy signal (left side of chart). The investor remains invested until the closing price drops back below the moving average (middle of chart), at which time a sell signal is generated and the investor moves back into cash. The investor then remains in cash until another buy signal is generated.
In a blog post that I wrote back in July, I tested the performance of several daily moving averages (20, 30, 40, and 50) as buy and sell indicators when investing in the marijuana sector ETF (HMMJ). For each moving average case, I calculated the investment return for the duration of the life of the ETF (from mid 2017 until present) and then compared the results to the case where the investor remains invested in the ETF for the entire duration (i.e. buy and hold).
At the time of the original blog post, an initial “buy and hold” investment in HMMJ returned 120% over two years, which is a very nice return over that time period. This result was similar to the trend-trading 50-day moving average case, which returned 133% over the same two-year period. The 40, 30, and 20 day moving average trend systems returned 230%, 265%, and 333%, respectively, outperforming “buy and hold” in each case by a wide margin.
As a follow up to the original article, I thought it would be interesting to update the results to include the additional five months that have elapsed since the initial analysis. In this analysis, I used the same moving averages (20, 30, 40, and 50) as trend indicators and simply back-tested the data again, bringing us up to the present date (Dec. 2nd, 2019). The results are illustrated below.
Given that the marijuana sector has been mired in a brutal bear market, it is not surprising to see that the out-performance of the “trend trading” system(s) versus the “buy and hold” case is even more pronounced than in the initial test period. Having remained fully invested during the previous five months, the “buy and hold” case total return dropped from the original 120% down to only 9%. The 20 MA trend system remained the strongest performer overall, returning 263% during the expanded test period, while the 30, 40 and 50 MA’s trend systems returned 238%, 211% and 133%, respectively. It is worth noting that in the time elapsed since the initial analysis was completed, the shorter MA systems generated several false “buy” signals, resulting in slightly lower returns than in the initial test period. However, these slightly diminished returns look even more favourable relative to the “buy and hold” case, which lost almost its entire return over the interim five-month period.
The analysis presented here clearly illustrates the merits of adopting a trend trading strategy in the marijuana sector. Indeed it can be shown that "buy and hold" strategies implemented by the mainstream financial services industry are likely to disappoint moving forward. In contrast, trend trading strategies have been used by certain hedge fund managers for many decades to deliver some of the strongest and most consistent performance across all market sectors in both bull and bear markets alike. If you are interested in maintaining your own trend trading stock or ETF portfolio, our unique trend identification methodology, model portfolios, and updated watch-lists can provide you with all the tools needed to build and manage your own high-performance portfolio. Check out our service at www.investthetrend.com