The Trend is Your Friend: How to Trade by Trend Following
Hi all, this week some troubling data has been released on the Turkish economy, and more sanctions have come hard and heavy on Russia. There is some interesting news on big investors getting into the car scene, and the FCA have decided that change is needed in the UK equity markets. Enjoy!
No Turkish Delight Here
Data from the Turkish Statistical Institute has revealed that last month the country’s inflation hit its highest level in 23 years. The Consumer Price Index (CPI) rose to 73.5% Year on Year, with food prices rising by 91.6% since May 2021. Late last year Turkey’s President Erdogan introduced what economists described as a ‘risky’ economic scheme in which interest rates were slashed – in an inflationary environment – with the intended outcome of lowering the price of Lira, which would have a knock-on effect of increasing exports from the country and reducing their trade deficit. Things have clearly not gone to plan and there is high discontentment amongst the public. Have a look at Peter's most recent article which takes a look at emerging markets like Turkey in detail.
Saudi Saviours?
Speaking of oil, Saudi Arabia are prepared to accelerate their oil production for western allies if the sanctions on Russia increase oil prices substantially. So far during the Ukraine-Russia conflict, the Saudis have swayed away from increasing oil output for the west as they have been cautious about how much they hold in reserve. However now they have had a change of heart – likely caused by the newly imposed sanctions this week. Many analysts believe that the new sanctions are risking oil outages in different regions around the globe, which would dramatically increase the odds of an oil-priced induced recession. Saudi Arabia is currently home to the most valuable public company in the world – Saudi Aramco, as its shares have rocketed during the energy crisis.
Pirates of the Baltic Sea
The UK Government alongside the EU have imposed insurance sanctions on ships carrying Russian oil, which will mean that Russian oil carriers will no longer be covered through the Lloyds of London insurance market. Lloyds of London is the world’s largest Marine insurance intermediary and has been operating for centuries. The news takes sanctions one step further from previous bans on pipelines running into mainland Europe. Russia’s main shipping routes travel through the Baltic Sea, the black sea, and the Arctic Ocean. This will likely have significant impacts on global commodities, with prices already through the roof. This will also mean that Russia will have to look in smaller insurance markets for cover. Since the start of conflict in Ukraine, Russia have been able to find alternative crude buyers through China, India, and Turkey. Can’t wait for my diesel bill to get even most expensive…
S&P GSCI Crude Oil
Rimac Run Riot
Up and coming Croatian electric car manufacturer Rimac have had an extremely successful funding round this week in which they raised €500m. Major investors within the funding round included Goldman Sachs and Japanese investing giant Softbank. The company have stated it intends to use these funds within their technology arm to enhance the secret ‘Robotaxi’ project they have been working on for the past three years.
Rimac was started only back in 2009 in the garage of the owner and is now one of the most sought after electric hyper car manufacturers and a major competitor to Tesla. The company aim to diversify their product portfolio and it believes there is extremely high potential in the automated taxi sector. Its founder Mate Rimac has stated that it is likely an IPO will come at some stage down the line, but they don’t want to rush it. Definitely a company worth keeping an eye on over the coming years.
Rimac Nevera – Price: $2.4 million
UK to up the ante on listings
The UK markets regulator has set out plans to shake up the current market structure, with the aim of attracting more start-up companies in order to keep up with fast growing financial markets in cities through Europe and the US. The current system in place uses a two-tiered platform, with a premium and standard section. The premium section involves higher regulatory requirements. Critics of the system have said that it creates a stigma around start-ups companies that want don’t want to be labelled as standard but want the regulatory freedom that this section provides. This move is also likely to be welcomed by UK Investment banks as it means more business for them through IPO services and consulting. It would also help create more tech sector jobs in the UK economy, which is vastly lagging behind the US.
Hope you enjoyed this week’s Market Wrap!
Patrick
The Basics of Trend Trading
As I continue to develop my knowledge and skills as a trader, I am beginning to sense that trend trading may be one of the most sustainable and trustworthy strategies for building capital. After all, "The trend is your friend" is an old adage in investing/trading with hedge fund billionaires such as Paul Tudor Jones and Bruce Kovner attributing their wealth to trend following. In this article, I will give a brief introduction to trend trading and outline some of the key indicators involved to encourage any newcomers to markets to think about incorporating trend following into their trading plan.
What is Trend Trading?
Trend traders make profits by purchasing assets that already have momentum (upwards or downwards), betting that this move will continue. This method therefore provides opportunities that have a much higher probability of success than strategies that attempt to pinpoint exact points of reversal or timing market lows as the method involves following the path of least resistance. Trend following strategies also exhibit remarkable persistence due to basic human nature which is associated with trends. Human nature hasn’t changed in millennia and is unlikely to do so any time soon.
Traders define and identify trends according to their own preferences, but most will agree that there are three major trends: uptrends, downtrends and sideways/range bound trends. They will also look to identify strong trends, as the stronger the trend the more higher the probability of the trade. A strong uptrend will show price to consistently make higher highs and higher lows while a strong downtrend will make lower lows and lower highs.
Strong Uptrend in S&P500 with higher highs and higher lows throughout 2021
Trend identifying can be made much simpler and robust by using exponential moving averages (EMA’s) which help to filter out the random noise generated from short term price action. An EMA is the same as a simple moving average (SMA) which takes the average of the closing prices over a certain period, except the more recent closes have a larger weighting. For trend identification, using multiple EMA’s can be very useful. For example we can authenticate that a trend is indeed an uptrend when:
· The 8 EMA is above the 21 EMA
· The 21 EMA is above the 34 EMA
· The 34 EMA is above the 55 EMA
· The 55 EMA is above the 89 EMA
Price chart for S&P500 with EMA’s stacked in a bullish manner confirming uptrend
The same can be said for identifying a downtrend except the EMA’s are stacked in the reverse order as shown in the price chart below for the iShares 20+ year Treasury Bond ETF which confirms the strong downtrend that long duration Treasuries have seen in 2022.
Price chart for TLT with EMA’s stacked in bearish manner confirming downtrend
For completeness, the chart below highlights an example of a sideways or range bound trend where the EMA’s show no clear pattern and repeatedly overlap each other like a twisted rope. Charts like these should be completely avoided when it comes to trend trading.
Price chart for Gold with EMA’s showing no clear direction of price indicating a sideways trend
It is also good practice for traders to see where price is relative to the 50 SMA before entering any trades. This prevents entering a trade prematurely before the continuation of the trend is fully confirmed. The 50 day SMA is also a widely recognised level in the industry so it regularly acts as support or resistance as price approaches it.
Momentum Indicators
Trend trading is highly dependent on clearly determining the price momentum of an asset so here I will introduce a couple of indicators which help identify momentum with ease. These are the stochastic oscillator and the Relative Strength Index (RSI). These indicators are often cited as “overbought/oversold” however describing them in this manner is relatively meaningless. They can be used much more effectively to determine entry points for trend trades.
The stochastic oscillator shows the closing price of an asset in relation to its price range over a given period. Using a “slow” stochastic (set to 8, 3, 3 on most trading platforms) can help traders validate entry positions. This can be interpreted as follows:
· In a strong uptrend if the stochastic reads <= 40 then the asset has pulled back enough for momentum to turn to the upside in which a bullish trade can be considered.
· In a strong downtrend if the stochastic reads >=60 then the asset has rallied enough relative to the downtrend in order for a bearish trade to be considered.
The chart below shows how the stochastic provided fantastic entry points for long positions on the S&P500 apart from once (red vertical line) along its strong uptrend during the better part of 2021.
Stochastic Oscillator provided highly profitable trend trade opportunities for S&P500 in 2021
The stochastic can be supplemented with the RSI to further enhance the probability of success for entry points. Rather than being concerned with the closing price of an asset relative to its trading range, the RSI measures the speed and magnitude of recent price changes. Using a 2-period RSI in context of an uptrend, a reading of 10 or below would highlight a relatively strong pullback. Therefore when the indicator reads below 10 then retraces back above 10, it is likely that the pullback is over and that the uptrend should continue.
Conversely, for downtrends a quick blip above 90 on the RSI should provide a solid entry point for a bearish trade. For example, the 2-period RSI temporarily breaching 90 nailed the exact highs for TLT in 2022 so far as seen in the chart below. The most recent price action is much choppier and unpredictable hence the RSI has not breached 90. Therefore this method has prevented traders from prematurely entering a risky short trade.
2-period RSI provided exceptional accuracy for entry points on TLT this year
I have only scratched the surface of trend trading in this article as there are endless additions that can be made to the strategy that increase the probability of profits. Take this as a teaser to trend trading as I will certainly be following up with more advanced concepts on the topic in future articles.
See you next week!
Ronan
Disclaimer
This communication is for informational and educational purposes only and should not be taken nor used as investment advice, as a personal recommendation, or solicitation to buy or sell any financial instrument. This material has been prepared without considering any particular recipient’s investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past or future performance of a financial instrument, index or structured product are not, and should not be taken as, a reliable indicator of future performance. I assume no liability as to the accuracy or completeness of the content of this publication.