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Technical Trading

Does technical trading work, or not? Rationalists dismiss it; behavioralists investigate it. Is there any verdict? These blog entries relate to technical trading.

SACEMS with Momentum Breadth Crash Protection

In response to “SACEMS with SMA Filter”, a subscriber suggested instead crash protection via momentum breadth (proportion of assets with positive momentum) by:

  1. Switching to 100% cash when fewer than four of eight Simple Asset Class ETF Momentum Strategy (SACEMS) non-cash assets have positive past returns.
  2. Scaling from cash into winners when four to eight risk assets have positive past returns (no cash for eight).
  3. Replacing U.S. Treasury bills (T-bills), a proxy for broker money market rates, with iShares Barclays 7-10 Year Treasury Bond (IEF) as “Cash.”

To investigate, we each month rank assets from the following SACEMS universe based on total returns over a specified lookback interval. We also each month measure momentum breadth for the eight non-cash assets using the same lookback interval.

PowerShares DB Commodity Index Tracking (DBC)
iShares MSCI Emerging Markets Index (EEM)
iShares MSCI EAFE Index (EFA)
SPDR Gold Shares (GLD)
iShares Russell 2000 Index (IWM)
SPDR S&P 500 (SPY)
iShares Barclays 20+ Year Treasury Bond (TLT)
Vanguard REIT ETF (VNQ)
3-month Treasury bills (Cash)

While emphasizing the suggested momentum breadth crash protection threshold, we look at all possible thresholds. While emphasizing a baseline lookback interval, we consider lookback intervals ranging from one to 12 months for the suggested momentum breadth threshold. We focus on compound annual growth rates (CAGR) and maximum drawdowns (MaxDD) for the equal-weighted (EW) Top 3 SACEMS portfolio, but also look at Top 1 and EW Top 2. We also look at EW Top 3 portfolio turnover. Using monthly dividend-adjusted closing prices for SACEMS assets and IEF and the T-bill yield during February 2006 (the earliest all ETFs are available) through December 2018, we find that: Keep Reading

Trend Following: Momentum or Moving Average?

Are moving averages or intrinsic (time series) momentum theoretically better for following trends in asset prices? In their November 2018 paper entitled “Trend Following with Momentum Versus Moving Average: A Tale of Differences”, Valeriy Zakamulin and Javier Giner compare from a theoretical perspective effectiveness of four popular trend following rules:

  1. Intrinsic Momentum – buy (sell) when the closing price at the end of a specified lookback interval is greater (less) than the closing price at the beginning of the lookback interval.
  2. Simple Moving Average – buy (sell) when the closing price at the end of a specified lookback interval is greater (less) than the equally weighted average closing price during the lookback interval.
  3. Linear Moving Average – buy (sell) when the closing price at the end of a specified lookback interval is greater (less) than the linearly weighted (weights linearly increasing to the most recent) average closing price during the lookback interval.
  4. Exponential Moving Average – buy (sell) when the closing price at the end of a specified lookback interval is greater (less) than the exponentially weighted (weights exponentially increasing to the most recent) average closing price during the lookback interval.

They transform these price rules into return-based versions and create a trend model as an autoregressive return process. They then explore interactions of the trading rules with the trend model. Based on this theoretical approach, they conclude that: Keep Reading

SACEVS with SMA Filter

“SACEMS with SMA Filter” examines whether applying a simple moving average (SMA) filter to “Simple Asset Class ETF Momentum Strategy” (SACEMS) winners improves strategy performance. Does such a filter improve performance of the “Simple Asset Class ETF Value Strategy” (SACEVS), which seeks diversification across the following three asset class exchange-traded funds (ETF) plus cash according to the relative valuations of term, credit and equity risk premiums?

3-month Treasury bills (Cash)
iShares 20+ Year Treasury Bond (TLT)
iShares iBoxx $ Investment Grade Corporate Bond (LQD)
SPDR S&P 500 (SPY)

Since many technical traders use a 10-month SMA (SMA10), we test effectiveness of requiring that each of the ETFs pass an SMA10 filter by comparing performances for three scenarios:

  1. Baseline – SACEVS as presented at “Value Strategy”.
  2. With SMA10 Filter – Run Baseline SACEVS and then apply SMA10 filters to dividend-adjusted prices of ETF allocations. If an allocated ETF is above (below) its SMA10, hold the allocation as specified (Cash). This rule is inapplicable to any Cash allocation.
  3. With Half SMA10 Filter – Same as scenario 2, but, if an allocated ETF is above (below) its SMA10, hold the allocation as specified (half the specified allocation and half cash at the T-bill yield).

We focus on compound annual growth rates (CAGR) and maximum drawdowns (MaxDD) of SACEVS Best Value, SACEVS Weighted and the 60%-40% SPY-TLT benchmark (60-40) portfolios. Using required SACEVS monthly historical data and monthly dividend-adjusted closing prices for the above asset class proxies and the yield for Cash over the period July 2002 (the earliest all ETFs are available) through November 2018, we find that: Keep Reading

SACEMS with SMA Filter

A subscriber asked whether applying a simple moving average (SMA) filter to  “Simple Asset Class ETF Momentum Strategy” (SACEMS) winners improves strategy performance. SACEMS each months picks winners from among the following asset class exchange-traded fund (ETF) proxies based on past returns over a specified interval:

PowerShares DB Commodity Index Tracking (DBC)
iShares MSCI Emerging Markets Index (EEM)
iShares MSCI EAFE Index (EFA)
SPDR Gold Shares (GLD)
iShares Russell 2000 Index (IWM)
SPDR S&P 500 (SPY)
iShares Barclays 20+ Year Treasury Bond (TLT)
Vanguard REIT ETF (VNQ)
3-month Treasury bills (Cash)

Since many technical traders use a 10-month SMA (SMA10), we test effectiveness of requiring that each winner pass an SMA10 filter by comparing performances for three scenarios:

  1. Baseline – SACEMS as presented at “Momentum Strategy”.
  2. With SMA10 Filter – Run Baseline SACEMS and then apply SMA10 filters to dividend-adjusted prices of winners. If a winner is above (below) its SMA10, hold the winner (Cash). This rule is inapplicable to Cash as a winner.
  3. With Half SMA10 Filter – Same as scenario 2, but, if a winner is above (below) its SMA10, hold the winner (half the winner and half cash at the T-bill yield).

We focus on compound annual growth rates (CAGR) and maximum drawdowns (MaxDD) of SACEMS Top 1, equally weighted (EW) Top 2 and EW Top 3 portfolios. Using monthly dividend-adjusted closing prices for the asset class proxies and the yield for Cash over the period February 2006 (the earliest all ETFs are available) through November 2018, we find that: Keep Reading

Most Effective U.S. Stock Market Return Predictors

Which economic and market variables are most effective in predicting U.S. stock market returns? In his October 2018 paper entitled “Forecasting US Stock Returns”, David McMillan tests 10-year rolling and recursive (inception-to-date) one-quarter-ahead forecasts of S&P 500 Index capital gains and total returns using 18 economic and market variables, as follows: dividend-price ratio; price-earnings ratio; cyclically adjusted price-earnings ratio; payout ratio; Fed model; size premium; value premium; momentum premium; quarterly change in GDP, consumption, investment and CPI; 10-year Treasury note yield minus 3-month Treasury bill yield (term structure); Tobin’s q-ratio; purchasing managers index (PMI); equity allocation; federal government consumption and investment; and, a short moving average. He tests individual variables, four multivariate combinations and and six equal-weighted combinations of individual variable forecasts. He employs both conventional linear statistics and non-linear economic measures of accuracy based on sign and magnitude of forecast errors. He uses the historical mean return as a forecast benchmark. Using quarterly S&P 500 Index returns and data for the above-listed variables during January 1960 through February 2017, he finds that: Keep Reading

Moving Average Timing of Stock Fundamental Ratios

Can investors time premiums associated with widely used stock/firm fundamental ratios? In their September 2018 paper entitled “It Takes Two to Tango: Fundamental Timing in Stock Market”, Fuwei Jiang, Xinlin Qi, Guohao Tang and Nan Huang use a simple moving average (SMA) trend indicator to time premiums associated with four fundamental stock/firm ratios: book-to-market (BM), earnings-to-price (EP), gross profitability (GP), and return-on-assets (ROA). In calculating these ratios, they lag accounting variables by six months to avoid look-ahead bias. For each ratio, they:

  • At the end of each June, rank stocks into tenths (deciles).
  • Each day, calculate value-weighted average returns for the deciles with the highest (highest BM, EP, GP, ROA) and lowest (lowest BM, EP, GP, ROA) expected returns and maintain price indexes for these two deciles.
  • Each day, hold a long (short) position in the decile with highest (lowest) expected returns only when the decile price index is above (below) its 20-day SMA, indicating an upward (downward) trend. When not holding a decile, hold Treasury bills.

As benchmarks, they each year buy and hold four portfolios that are each long (short) the value-weighted deciles with the highest (lowest) expected returns for one of the fundamental ratios. While focusing on a 20-day SMA, for robustness they also test SMAs of 10, 50, 100 and 200 trading days. While focusing on value weighting, they also look at equal weighting. They run tests on both non-financial Chinese A-share stocks and non-financial U.S. common stocks. Using annual groomed fundamentals data and daily returns for Chinese stocks during January 2001-December 2017 and for U.S. stocks during July 1970-December 2017, and contemporaneous Treasury bill yields, they find that:

Keep Reading

Distinct and Predictable U.S. and ROW Equity Market Cycles?

A subscriber asked: “Some pundits have noted that U.S. stocks have greatly outperformed foreign stocks in recent years. What does the performance of U.S. stocks vs. foreign stocks over the last N years say about future performance?” To investigate, we use the S&P 500 Index as a proxy for the U.S. stock market and the ACWI ex USA Index as a proxy for the rest-of-world (ROW) equity market. We consider three ways to relate U.S. and ROW equity returns:

  1. Lead-lag analysis between U.S. and ROW annual returns to see whether there is some cycle in the relationship.
  2. Multi-year correlations between U.S. and next-period ROW returns, with periods ranging from one to five years.
  3. Sequences of end-of-year high water marks for U.S. and ROW equity markets.

For the first two analyses, we relate the U.S. stock market to itself as a control (to assess whether ROW market behavior is distinct). Using end-of-year levels of the S&P 500 Index and the ACWI ex USA Index during 1987 (limited by the latter) through 2017, we find that: Keep Reading

Predicting Crypto-asset Returns with Past Returns-Volume

Do crypto-asset trading volumes usefully predict returns? In the August 2018 draft of their paper entitled “Trading Volume in Cryptocurrency Markets”, Daniele Bianchi and Alexander Dickerson investigate the power of crypto-asset trading volumes to predict future returns. They calculate volumes and returns based on either 12-hour or 24-hour intervals. They process these inputs as follows:

  • To detect volume abnormalities, they estimate its log deviation from trend over a rolling 21-interval window. To put different crypto-assets on an equal footing, they then standardized by dividing by its log standard deviation over the same window.
  • They measure past returns over the same interval, denominated in bitcoins, (thereby including Bitcoin only indirectly). To emphasize the most liquid exchanges, they weight returns by volume when aggregating.

To assess economic significance of findings, they double-sort crypto-assets first into two to four groups ranked by the return metric and then within each group into three or four subgroups ranked by the volume metric. Using intraday (10-minute) price and volume data for 26 crypto-assets from over 150 exchanges (90% of total crypto-asset market capitalization), each denominated in bitcoins, during January 1, 2017 through May 10, 2018, they find that:

Keep Reading

A Few Notes on Buy the Fear, Sell the Greed

Larry Connors introduces his 2018 book, Buy the Fear, Sell the Greed: 7 Behavioral Quant Strategies for Traders, by stating in Chapter 1 that the book shows when, where and how: “…to trade directly against traders and investors who are having…feelings of going crazy and impending doom. …The goal of this book is to make you aware of when and why short-term market edges exist in stocks and in ETFs, and then give you the quantified strategies to trade them. …Thirty years ago, when a news event would occur, it could take days to assimilate it. …The only thing that’s changed is the timing of their emotion; today it occurs faster and at times is more extreme primarily due to the role the media (and especially social media) plays in disseminating the news that triggers this behavior.” Based on analyses of specific trading setups using data through 2017, he finds that: Keep Reading

RSP/SPY as a Stock Market Breadth Indicator

A reader proposed: “I recently found something interesting while analyzing the ratio of the equal-weighted S&P 500 Index to its market capitalization-weighted counterpart. Whenever this ratio declines (out of an uptrend), the market crashes (July 2007, September-October 2008, July 2011). Also, when this ratio starts rising, the recovery commences (April 2009). The indicator seems to warn of problematic times ahead. …Perhaps this ratio provides insight into whether money is moving into the market (ratio rising) or out of the market (ratio falling). Could you take a look at this to see whether this ratio is a great indicator?” To investigate, we use SPDR S&P 500 (SPY) and Invesco S&P 500 Equal Weight (RSP) as tradable proxies for the capitalization-weighted and equal-weighted S&P 500 Index, respectively. Using weekly dividend-adjusted prices of SPY and RSP from the end of April 2003 (limited by RSP) through July 2018 (796 weeks), we find that: Keep Reading

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