I much enjoy Michael Harrisâ Price Action LabBlog and have listed it in the websites section here at Traders Place. I have been working my way through Michaelâs articles on trend following and in particular his article âIs There Any Future in Equity Index Trend-Following?â gave me pause for thought and prompted me to do a little research of my own.
Michael states:
âThe problem of trend following is fundamentally simple: choppy markets reduce the effectiveness of trend-following algorithms and shorter trend durations reduce their profitability. There is no need for a more sophisticated analysis. â
âAn example of a trend following system that shows how recent conditions have affected the robustness and efficiency of such methods is the 50-200 MA cross system. Basically, this is a long/short symmetric system that establishes long positions when the 50-day MA crosses above the 200-day MA and exits and reverses when the opposite happens. This system has worked very well in SPY since 1994 and even during 2008 with a return close to 34%. But after 2009 this system stopped performing well because, as will shall see via the help of a special indicator I have developed, the market dynamics changed drastically for a period of almost two year. During that period the system was subjected to a large drawdown of about -38%.â
One of the points raised and shown in the chart was as follows:
âThe bottom pane shows the downtrend in the duration between two consecutive MA crosses of the system and the downtrend is clear.â
It sounds logical enough to me. If the markets have become âchoppyâ and have recently moved sideways more often than they have trended, then surely this would show up in shorter trade lengths over an entire portfolio and not just in the S&P?
In my âTrend Efficiency Indexâ I showed that trends are noisier now â there much retracement on the journey from point A to point B. Again, surely one result of this should be that trades in general have become shorter in length in recent years, not only in the S&P but also across the board?
I took Michaelâs work a few stages further. I took back adjusted price series for a portfolio of 107 futures contracts: 14 bonds, 10 currencies, 8 energy contracts, 13 grain contracts, 8 short term interest rates, 13 metals, 4 âotherâ, 10 softs, 24 stock indices. No attempt therefore to balance the portfolio. I tested with single contracts rather than fixed fractional position sizing and no risk constraints â each trade was taken unless it was a locked limit day in the relevant market (in which case the trade was taken on the next available day). The system was a simple dual moving average identical to that Michael used, taking both long and short trades: a reversal system. I tested in the ratio of 1:4 SMA:LMA. Beginning at â5 and 20âand ending at â50 and 200â. For completeness sake a also tried a couple of other variations: â25 and 200â; â10 and 200â.
I tested for the period 1st January 1970 to date. I made no allowance for the fact that during that time, the number of contracts available increased dramatically â for these purposes it should not matter.
To my surprise, a visual examination of the charts showed little difference in trade length over the years.
But.............the addition of trend lines to the charts told a different and more complex story.
Anthony FJ Garner
Michael states:
âThe problem of trend following is fundamentally simple: choppy markets reduce the effectiveness of trend-following algorithms and shorter trend durations reduce their profitability. There is no need for a more sophisticated analysis. â
âAn example of a trend following system that shows how recent conditions have affected the robustness and efficiency of such methods is the 50-200 MA cross system. Basically, this is a long/short symmetric system that establishes long positions when the 50-day MA crosses above the 200-day MA and exits and reverses when the opposite happens. This system has worked very well in SPY since 1994 and even during 2008 with a return close to 34%. But after 2009 this system stopped performing well because, as will shall see via the help of a special indicator I have developed, the market dynamics changed drastically for a period of almost two year. During that period the system was subjected to a large drawdown of about -38%.â
One of the points raised and shown in the chart was as follows:
âThe bottom pane shows the downtrend in the duration between two consecutive MA crosses of the system and the downtrend is clear.â
It sounds logical enough to me. If the markets have become âchoppyâ and have recently moved sideways more often than they have trended, then surely this would show up in shorter trade lengths over an entire portfolio and not just in the S&P?
In my âTrend Efficiency Indexâ I showed that trends are noisier now â there much retracement on the journey from point A to point B. Again, surely one result of this should be that trades in general have become shorter in length in recent years, not only in the S&P but also across the board?
I took Michaelâs work a few stages further. I took back adjusted price series for a portfolio of 107 futures contracts: 14 bonds, 10 currencies, 8 energy contracts, 13 grain contracts, 8 short term interest rates, 13 metals, 4 âotherâ, 10 softs, 24 stock indices. No attempt therefore to balance the portfolio. I tested with single contracts rather than fixed fractional position sizing and no risk constraints â each trade was taken unless it was a locked limit day in the relevant market (in which case the trade was taken on the next available day). The system was a simple dual moving average identical to that Michael used, taking both long and short trades: a reversal system. I tested in the ratio of 1:4 SMA:LMA. Beginning at â5 and 20âand ending at â50 and 200â. For completeness sake a also tried a couple of other variations: â25 and 200â; â10 and 200â.
I tested for the period 1st January 1970 to date. I made no allowance for the fact that during that time, the number of contracts available increased dramatically â for these purposes it should not matter.
To my surprise, a visual examination of the charts showed little difference in trade length over the years.
But.............the addition of trend lines to the charts told a different and more complex story.
Anthony FJ Garner
