As a trend trader I aim for simple. Simple methods, simple charts, simple execution. When a strategy becomes too complex it can handcuff the trader. If the process has too many variables getting a clear signal is very difficult.
It is commonly known that a trader's path moves from complex to simple. At first the appeal of indicators seeking a "magic formula" is often the driving motivation. But as the trader becomes more seasoned in the market they realize there is no perfect indicator. Without the appreciation of price action as the leading indicator most methods will fail.
For the vast majority of market participants taking a longer timeframe will improve results as well. In a world of high frequency trading, becoming a low frequency trader is one way to limit the impact of this new market opponent.
What we basically seek with an active management strategy is a way to identify strong performing stocks at the correct time to take advantage of a shift in momentum. An active strategy should also protect against large downside adjustments in prices.
The best way I have found to participate in up markets while avoiding catastrophic losses is to follow the trends. The path of least resistance is to trade in the direction of the dominant trend. If you want to make money its a good idea to pick stocks that are currently moving in the desired direction.
The basic tenants of my active investment strategies are to follow the trend, respect the price action, and avoid noisy signals that do not improve my returns. I am on a constant journey to improve the clarity of these rules.
Over time I have tested different methods and timeframes. Depending on the asset, some will behave better with specific rules. Large Cap stocks tend to offer clearer signals with less fake outs on longer timeframes. This suggests Weekly charts perform better than Daily and Monthly perform better than Weekly.
The inherent trouble with any longer-term strategy is slippage; should the stock move adversely through the stop level rapidly, larger than expected losses can stack up before a valid sell signal triggers. The rapid loss of market cap is generally more pronounced in the smaller capitalization stocks. These can have swings of 50% or more in one month's time should bad news hit the company. For these assets, waiting for a Monthly signal can create substantial losses. But with the high quality Blue-Chip companies in the S&P100 rapid declines of this magnitude are much less frequent. Large Cap stocks also tend to pay dividends which is an additional reward to longer-term holders.
With exceptionally strong companies that grow over time, the long-term trends can be significant. If you use a shorter timeframe it is almost impossible to stick with a move long enough for a huge winner to materialize. Using LMT as an example of this, here is a look at both the Daily and Monthly charts:
LMT Daily
LMT Monthly
Had a Daily timeframe been used it would have been very difficult stick with the stock long enough to capture the seemingly "perfect" uptrend that resulted in a 250% rally since the 2013 breakout.
*Granted the recent bull market has been exceptional, the trends have been very strong and steady. But if you have been participating in the stock market since the '09 bottom, very little has been "easy" about sticking with the uptrend. Looking back in hindsight its obvious that this was an easy trend to ride, but living through the day-to-day noise didn't have the feel of a smooth ride I assure you.
This is why stepping back a little bit, removing yourself from the day-to-day wiggle of the market and CNBC, can be very beneficial to your long-term returns.
-Using the longer-timeframe can be helpful for initial entry placement. If you wait until a stock consolidates into the 20 Month SMA, it will have built a very substantial base formation. This "base" should form over a multiple months which often results from a fairly sizable pullback on the lower timeframes. But there is no reason to go barreling into a stock that is moving lower or sideways, it could certainly continue to do so for many more months in the future. This is where waiting for a resumption of uptrend is beneficial.
The next modification for the Lg-Cap Portfolio is to clean up our entry and stop criteria. Since we are adjusting our timeframe to capture the larger Monthly trends, we want to be able to participate in as timely a way as possible.
Based on my backtesting and monitoring in real time, a consolidation into the rising 20 MMA that then "kicks off" above the highest closing price of at least 4-months offers a strong entry signal. As the trend progresses more of these "flag" like pullbacks will occur allowing for more opportunities to add to positions and/or trail stops to the next valid level.
Using SHW as an example of this we can see many of these "flag" like patterns:
SHW Monthly
With our latest purchase of SHW we can take a look at the ongoing risk management and stop placement:
A highly effective and simple placement for the initial stop is the lower boundary of the breakout bar's range. SHW triggered this signal at the close of March by breaking above the "flag's" downtrend resistance. We can then place our stop at the March low just above $270.
A violation of that low would signal a failed breakout and would mean our thesis is invalided based on trend and momentum.
This stop will be monitored on a Monthly closing basis. Yes that's a slow signal, and yes there will be slippage that occurs. But it is also one of the most effective methods of timely trend participation I have found for Large Cap stocks.
Also note my preferred charting "style" will be this single bar, closing price format. With this simple chart structure I can cleanly see what I need to: price, trend, and the prior closes of each monthly bar. It occurs to me that "candlestick charts" can add an additional bias to the price action that I don't find particularly helpful for my style of trading. "Hammers", "Hanging Man", "Doji" are all popular candlestick formations but by their nature are often one or two bar signals and tend to be more short-term and noisy. This is not to say that many people can't trade them successfully, I'm sure they do. But for me and my goals I find them distracting and mostly emotional indications of price action.
The market has seen a solid consolidation since the middle of 2015. This basing period has allowed many strong uptrending stocks to reset toward their longer-term averages.
We have entered a few that have resumed higher out of their bases recently (SHW, UNH, MDT) and there are several more interesting formations setting up right now.
+LOW
Lowe's is offering a very strong signal this month. This is a buy at the close of the month on Tuesday. We will use the May low at $74.55 as our stop.
+CMCSA
NKE
What I love about the monthly timeframe is that most participants and Wall Street are quite sour on NKE at the moment. It is true when they say participants always get most bearish the closer price is near support.
The media is talking, Footlocker just posted a bad quarter. Who cares?! When was the last time you went to Footlocker for sneakers? But you're wearing shoes aren't you ; ) Footlocker is part of "the mall is dead" theory and has nothing to do with Nike. As we can see, NKE is now testing substantial historical support in a robust uptrend. A resumption through this downtrend resistance would kick-off a new uptrend and I would be a buyer.
SBUX
PCLN
Priceline has offered some very nice signals since 2012. The latest Buy signal at the end of 2015 did fail recently as the monthly bar for January closed below the low of the October breakout signal. It is worth noting that from the initial entry signal in February of 2012 the stock posted a gain of +70% compared to a +42% gain for the SP500 over that same period. Now we await a new signal.
COST
PPG
PPG also had a stop triggered after a massive 150% rally from its 2012 breakout signal. Again, compared to +45% in the S&P, that is outperformance we want to capture.
CVS
Recap
-This is not a very different way of looking at stocks than before. It appears if we remain a little more patient better returns can follow. There will be times where it will seem crazy to stick with a stock this long. Through my testing of the SP100 stocks I track, there have been draw downs in individual names up to 50% without receiving an exit signal. But this kind of patience is exactly why I feel the strategy can improve our long-term returns. You have to be willing to do things the majority will not to create out sized opportunities. It pays to think differently than the majority. That doesn't mean be a mindless contrarian, constantly taking bets against the overall market. It means if most traders are caught up in the day-to-day volatility of the market and the noise associated with that, those will be the traders who batter their brains in, scrambling for mediocre returns.
-The plan revisions:
1. Seek stocks trading above a rising 20 Month SMA (i.e. Long-term uptrend)
2. Enter on a breakout above at least 4-months of closing prices after a consolidation near the 20 Month SMA
3. Size positions against the low of the breakout bar or recent pivot low (which ever represents the trend and setup best). This will be the stop on a monthly basis.
4. Trail stops once a new consolidation forms and resumes higher based on above rules.
5. An alternate stop that I have tested is the inverse of the buy signal (a bear flag below the 20 Month SMA setting a new 4-month closing low). This is helpful in the event of a strong vertical rally that doesn't offer a higher trailing stop. Should a bearish formation occur, it can be used as an effective exit location.
6. Take initial profits after 100% gain. No sooner and only once. We need to let our winning trades run. IF a position doubles we will take out our cost on the trade and let the profits ride.
7. Hold on for dear life.
The hardest part of the process will be patience, both on the entry side and exit side. There will be times when we feel left out as stocks don't consolidate for a period of time. There will be other times when our stops "seem" too far away and will be uncomfortable with the volatility we are experiencing.
-I feel this adjustment will help reduce bias even more so. This is a very black and white picture. Either the stock is above the most recent valid breakout or it isn't. There will be times when this is not easy. As my study has shown me often large open gains will be given back only to hold less than 1% from the stop and then reverse higher and rally 200%. That's something that will test your conviction in a live trade. The backtest is easy, everything "makes sense" in hindsight. Its the actual application of the strategy that involves emotions, this will be the real challenge.
As history has shown us, holding for the longer-term works. Whether past results can be extrapolated into the future I don't fully know. But I do know that the primary obstacles for a traders' success have mostly to do with over-trading, having emotional reactions without a plan, not compounding dividends, commission costs from highly active trading, taking excessive risks, taxes, etc. This adjustment should make improvements in all of those areas.
Sticking with the dominant trend works, I know this. Trend followers have more than 200 years of history backing their methods. The key has always been to hit big winners and keep losses small. Again, if history is any guide, this structure will yield strong results over time.
The primary driver of this adjustment is to seek stronger signals (both entry and exit), stick with winning trades longer, reduce trading noise along with the costs associated, and to more efficiently use my time and research.
Limiting signals will allow more time to focus on improving other areas of my process and creating a less stressful overall lifestyle.
Something I have suspected for some time and have recently been observing more is that to operate more successfully in the market its best to be on either end of the spectrum. Either trade short-term or long-term. If you find yourself in the middle there will be a lot of choppy and frustrating trading. As I've stated above if you trade like everyone else the odds will be stacked against you. You need to adapt strategies that the majority don't understand and/or don't have the patience/discipline to execute.
This change will also allow for a more consistent structure to the ZenTrends blog. I've noticed lately that the "Lg-Cap Portfolio Review" posts are getting less attention than other more broad market review posts. By focusing the portfolio on a Monthly basis I only will post a Lg-Cap Portfolio Review at the end of each month. I will also post a "Monthly Signal Watchlist" the week before the end-of-month signals execute. The other weeks will be dedicated to general market conditions, things I'm watching, some short-term trading, etc.
Thanks for reading.
-ZT
This stop will be monitored on a Monthly closing basis. Yes that's a slow signal, and yes there will be slippage that occurs. But it is also one of the most effective methods of timely trend participation I have found for Large Cap stocks.
Also note my preferred charting "style" will be this single bar, closing price format. With this simple chart structure I can cleanly see what I need to: price, trend, and the prior closes of each monthly bar. It occurs to me that "candlestick charts" can add an additional bias to the price action that I don't find particularly helpful for my style of trading. "Hammers", "Hanging Man", "Doji" are all popular candlestick formations but by their nature are often one or two bar signals and tend to be more short-term and noisy. This is not to say that many people can't trade them successfully, I'm sure they do. But for me and my goals I find them distracting and mostly emotional indications of price action.
The market has seen a solid consolidation since the middle of 2015. This basing period has allowed many strong uptrending stocks to reset toward their longer-term averages.
We have entered a few that have resumed higher out of their bases recently (SHW, UNH, MDT) and there are several more interesting formations setting up right now.
+LOW
+CMCSA
Comcast is due to signal an entry at the close of May this coming Tuesday. We will use the low from the month at $59.60 as our stop.
+CSCO
Cisco has been a very choppy and rangebound stock since its great implosion in 2000. It does appear to be attempting a breakout that could finally move it out of its 15-year sideways range. Should it close Tuesday above 28.70 we can take a Long position using the May low at $25.80 as our stop.
The media is talking, Footlocker just posted a bad quarter. Who cares?! When was the last time you went to Footlocker for sneakers? But you're wearing shoes aren't you ; ) Footlocker is part of "the mall is dead" theory and has nothing to do with Nike. As we can see, NKE is now testing substantial historical support in a robust uptrend. A resumption through this downtrend resistance would kick-off a new uptrend and I would be a buyer.
SBUX
PCLN
COST
PPG
CVS
JPM
Recap
-This is not a very different way of looking at stocks than before. It appears if we remain a little more patient better returns can follow. There will be times where it will seem crazy to stick with a stock this long. Through my testing of the SP100 stocks I track, there have been draw downs in individual names up to 50% without receiving an exit signal. But this kind of patience is exactly why I feel the strategy can improve our long-term returns. You have to be willing to do things the majority will not to create out sized opportunities. It pays to think differently than the majority. That doesn't mean be a mindless contrarian, constantly taking bets against the overall market. It means if most traders are caught up in the day-to-day volatility of the market and the noise associated with that, those will be the traders who batter their brains in, scrambling for mediocre returns.
-The plan revisions:
1. Seek stocks trading above a rising 20 Month SMA (i.e. Long-term uptrend)
2. Enter on a breakout above at least 4-months of closing prices after a consolidation near the 20 Month SMA
3. Size positions against the low of the breakout bar or recent pivot low (which ever represents the trend and setup best). This will be the stop on a monthly basis.
4. Trail stops once a new consolidation forms and resumes higher based on above rules.
5. An alternate stop that I have tested is the inverse of the buy signal (a bear flag below the 20 Month SMA setting a new 4-month closing low). This is helpful in the event of a strong vertical rally that doesn't offer a higher trailing stop. Should a bearish formation occur, it can be used as an effective exit location.
6. Take initial profits after 100% gain. No sooner and only once. We need to let our winning trades run. IF a position doubles we will take out our cost on the trade and let the profits ride.
7. Hold on for dear life.
The hardest part of the process will be patience, both on the entry side and exit side. There will be times when we feel left out as stocks don't consolidate for a period of time. There will be other times when our stops "seem" too far away and will be uncomfortable with the volatility we are experiencing.
-I feel this adjustment will help reduce bias even more so. This is a very black and white picture. Either the stock is above the most recent valid breakout or it isn't. There will be times when this is not easy. As my study has shown me often large open gains will be given back only to hold less than 1% from the stop and then reverse higher and rally 200%. That's something that will test your conviction in a live trade. The backtest is easy, everything "makes sense" in hindsight. Its the actual application of the strategy that involves emotions, this will be the real challenge.
As history has shown us, holding for the longer-term works. Whether past results can be extrapolated into the future I don't fully know. But I do know that the primary obstacles for a traders' success have mostly to do with over-trading, having emotional reactions without a plan, not compounding dividends, commission costs from highly active trading, taking excessive risks, taxes, etc. This adjustment should make improvements in all of those areas.
Sticking with the dominant trend works, I know this. Trend followers have more than 200 years of history backing their methods. The key has always been to hit big winners and keep losses small. Again, if history is any guide, this structure will yield strong results over time.
The primary driver of this adjustment is to seek stronger signals (both entry and exit), stick with winning trades longer, reduce trading noise along with the costs associated, and to more efficiently use my time and research.
Limiting signals will allow more time to focus on improving other areas of my process and creating a less stressful overall lifestyle.
Something I have suspected for some time and have recently been observing more is that to operate more successfully in the market its best to be on either end of the spectrum. Either trade short-term or long-term. If you find yourself in the middle there will be a lot of choppy and frustrating trading. As I've stated above if you trade like everyone else the odds will be stacked against you. You need to adapt strategies that the majority don't understand and/or don't have the patience/discipline to execute.
This change will also allow for a more consistent structure to the ZenTrends blog. I've noticed lately that the "Lg-Cap Portfolio Review" posts are getting less attention than other more broad market review posts. By focusing the portfolio on a Monthly basis I only will post a Lg-Cap Portfolio Review at the end of each month. I will also post a "Monthly Signal Watchlist" the week before the end-of-month signals execute. The other weeks will be dedicated to general market conditions, things I'm watching, some short-term trading, etc.
Thanks for reading.
-ZT
Great post!!! Thanks for sharing
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