TREND Following Mar2016 by Ricardo Ronco

8/17/2019 TREND Following Mar2016 by Ricardo Ronco

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TREN

FOLLOWING

Applied to Equities and ETFs

March 2015 – New York

Riccardo Ronco +44 20 7233 3245 [email protected]


2/27

Riccardo Ronco, CFTeBiography

Riccardo Ronco +44 20 7233 3245 [email protected] 2

Riccardo Ronco is the head of technical analysis at Aviate Global in London.

Mr. Ronco follows large- and mid-cap European and U.S. equities, paying attention to domestic andforeign equity indices, currencies, commodities, and interest rates. As a medium-term trend follower,his approach is strongly quantitative in nature; particular attention, however, is devoted to identifyingreversal patterns characterized by excessive consensus among investors.

Mr. Ronco brings more than 15 years of experience in trading, quantitative analysis, and teachingtechnical analysis in the United Kingdom and Italy. Prior to joining Aviate Global in April 2010,Mr. Ronco worked for Credit Agricole Indosuez, Banca Intesa Group, and Banca AntonVeneta(MontePaschi Group) and FBR Capital Markets.

He is a frequent guest on CNBC Europe and other European media outlets. A member of theSociety of Technical Analysts (STA) and the Market Technicians Association (MTA), Mr. Ronco was aspeaker at the International Federation of Technical Analysts (IFTA) 1998 conference in Rome andBeijing (2011).

His work is mentioned in the book Capital Market Revolution: The Future of Markets in an Online World by Patrick Young. Mr. Ronco received his degree (with honors) in economics from theUniversity of Turin.

He currently holds Chartered Market Technician (CMT) Level 1 and 2 diplomas.


3/27

Buffett or Harding?



4/27

Emotional = Irrational


•Investors tend to make emotional decisions about their money, chasing performance...

•Investors are everything but rational: Hope, Greed, Fear, Despair “investing” cycle


5/27

Behavioral Basis for Trends


“Demystifying Managed Futures”, Hurst Ooi Pedersen

Fundamental Value

Trend starts (anchoring

+ under-reaction)

Trend continues (herding +

over-reaction)

Trend ends

(back to fundamentals)

People are prone to making SYSTEMATIC ERRORS in circumstances of uncertainty


6/27

Why Trend Following?


•To fight irrational behaviour we need a PLAN: a system with clear rules, with an EDGE

•TREND: sustained changes in prices in one direction

•FOLLOWING: no forecast, focus on reaction, deal with probabilities and not certainties

•We cannot control the OUTCOME of a trade: focus on SIZE and EXIT

•Focus on ROBUSTNESS: simple algo, few degrees of freedom, KISS

•Focus on Consistency DisciplineConfidence Back testing

•Focus on the PROCESS: doing the right thing rather than being right, “flawless execution”

•Simple but not EASY: “let profits run + cut losses” goes against our natural instincts


7/27

From David Ricardo (1772-1823) to Ed Seykota


“The Great Metropolis”, Vol II, 1838, James Grant


8/27

Trend Following Wisdom

818 March 2015 Riccardo Ronco +44 20 7233 3245 [email protected]

"A loss never bothers me after I take it, I forget if overnight.But being wrong, not taking the loss - that is what does

damage to the pocket book and to the soul.“

Jesse Livermore

“After spending many years in Wall Street

and after making and losing millions of

dollars I want to tell you this: it never was

my thinking that made the big money for

me. It was always my sitting.”

Jesse Livermore


9/27

An Edge to avoid Outcome Bias

9Riccardo Ronco +44 20 7233 3245 [email protected]

Expectation = (%W x AW) – (%L x AL)Where:

%W = Winning Percent

AW = Average Winner

%L = Losing Percent or (1 - %W)AL = Average Loser

For Expectation = 0 we have the “Breakeven Line” curve

Y = (1 – X) / X hyperbolaWhere:

Y = AW / AL (a.k.a. WIN/LOSS ratio) X = %W


10/27

Expectancy Curve – Nick Radge


0

1

2

3

4

5

6

7

8

9

10

10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% 95%

WIN %

W I N / L O S S R A T I O

Profitable

Unprofitable

Breakeven Line


11/27

NR 1 TF problem: DRAWDOWNS


•TF is about taking NUMEROUS SMALL LOSSES (false breakouts) for...

•... those RARE LARGE WINNING TRADES when markets do trend (“fat tails”)

•Length and Size of a LOSING streak affects you psychologically and emotionally

=ROUND(LN(Nr. Trades) / -LN((1 – (% WIN / 100))),0)

Example:

40% WIN and 10,000 trades 18

There is a chance that we can have 18 consecutive losers


12/27

Psychology: Length of a Losing Streak


10

40

70

99

0

10

20

30

40

50

60

70

80

90

5 0 0

1 0 0 0

1 5

0 0

2 0

0 0

2 5 0 0

3 0 0

0

3 5 0 0

4 0 0 0

4 5 0 0

5 0 0 0

5 5 0 0

6 0 0 0

6 5 0 0

7 0 0 0

7 5 0 0

8 0 0 0

8 5 0 0

9 0 0 0

9 5 0 0

1 0 0 0 0

80-90

70-80

60-70

50-60

40-50

30-40

20-30

10-20

0-10

TRADES

% WIN


13/27

Psychology: Fixed Fractional


•the RISK on EACH TRADE does impact how we trade / think (100 starting capital)

0

10

20

30

40

50

60

70

80

90

100

1 4 7 1 0

1 3

1 6

1 9

2 2

2 5

2 8

3 1

3 4

3 7

4 0

4 3

4 6

4 9

5 2

5 5

5 8

6 1

6 4

6 7

7 0

7 3

7 6

7 9

8 2

8 5

8 8

9 1

9 4

9 7

1 0 0

1

2

3

4

5

Consecutive

Losses

% risk / loss

•If our %WIN is 40% then, in the long run, we will get 18 losses in a row

•risk 4% on each trade and that will be enough to lose 50% of our equity with FF

Avail. Cap.


14/27

S&P 500 vs 10-month SMA Long only


From Sept 1928 to Feb 2015: CAGR Strategy +6.38% (no reinv.) vs B&H 5.47%

10

100

1000

10000

100000

0 1 / 0 9 / 1 9 2 8

0 1 / 0 6 / 1 9 3 1

0 1 / 0 3 / 1 9 3 4

0 1 / 1 2 / 1 9 3 6

0 1 / 0 9 / 1 9 3 9

0 1 / 0 6 / 1 9 4 2

0 1 / 0 3 / 1 9 4 5

0 1 / 1 2 / 1 9 4 7

0 1 / 0 9 / 1 9 5 0

0 1 / 0 6 / 1 9 5 3

0 1 / 0 3 / 1 9 5 6

0 1 / 1 2 / 1 9 5 8

0 1 / 0 9 / 1 9 6 1

0 1 / 0 6 / 1 9 6 4

0 1 / 0 3 / 1 9 6 7

0 1 / 1 2 / 1 9 6 9

0 1 / 0 9 / 1 9 7 2

0 1 / 0 6 / 1 9 7 5

0 1 / 0 3 / 1 9 7 8

0 1 / 1 2 / 1 9 8 0

0 1 / 0 9 / 1 9 8 3

0 1 / 0 6 / 1 9 8 6

0 1 / 0 3 / 1 9 8 9

0 1 / 1 2 / 1 9 9 1

0 1 / 0 9 / 1 9 9 4

0 1 / 0 6 / 1 9 9 7

0 1 / 0 3 / 2 0 0 0

0 1 / 1 2 / 2 0 0 2

0 1 / 0 9 / 2 0 0 5

0 1 / 0 6 / 2 0 0 8

0 1 / 0 3 / 2 0 1 1

0 1 / 1 2 / 2 0 1 3

S&P 500 MA

B&H


15/27

Reinvesting in US 10-year T-Note


100

1000

10000

0 1 / 1 0 / 1 9 8 8

0 1 / 0 8 / 1 9 8 9

0 1 / 0 6 / 1 9 9 0

0 1 / 0 4 / 1 9 9 1

0 1 / 0 2 / 1 9 9 2

0 1 / 1 2 / 1 9 9 2

0 1 / 1 0 / 1 9 9 3

0 1 / 0 8 / 1 9 9 4

0 1 / 0 6 / 1 9 9 5

0 1 / 0 4 / 1 9 9 6

0 1 / 0 2 / 1 9 9 7

0 1 / 1 2 / 1 9 9 7

0 1 / 1 0 / 1 9 9 8

0 1 / 0 8 / 1 9 9 9

0 1 / 0 6 / 2 0 0 0

0 1 / 0 4 / 2 0 0 1

0 1 / 0 2 / 2 0 0 2

0 1 / 1 2 / 2 0 0 2

0 1 / 1 0 / 2 0 0 3

0 1 / 0 8 / 2 0 0 4

0 1 / 0 6 / 2 0 0 5

0 1 / 0 4 / 2 0 0 6

0 1 / 0 2 / 2 0 0 7

0 1 / 1 2 / 2 0 0 7

0 1 / 1 0 / 2 0 0 8

0 1 / 0 8 / 2 0 0 9

0 1 / 0 6 / 2 0 1 0

0 1 / 0 4 / 2 0 1 1

0 1 / 0 2 / 2 0 1 2

0 1 / 1 2 / 2 0 1 2

0 1 / 1 0 / 2 0 1 3

0 1 / 0 8 / 2 0 1 4

SPX/BOND

S&P B&H

50/50

Oct 1988 – Feb 2015 CAGR Max DD

SPY/Bond 10-sma (blue) 13.31% -15.87%

SPY Buy & Hold (red) 10.37 -50.95%

SPY/Bond 50/50 (green) 9.46% -22.00%


16/27

So what is the “best” moving average?


No commissions, no taxes, no reinvestment when in cash


17/27

Trade them all! (and play with weights)




18/27

From Bullish/Bearish to How MUCH Bullish...




19/27

Mebane Faber: CTA-like using 10-month m.a.


No commissions, no taxes, YES reinvestment when in cash (SHY)

100

1000

0 1 / 1 2 / 1 9 9 5

0 1 / 0 8 / 1 9 9 6

0 1 / 0 4 / 1 9 9 7

0 1 / 1 2 / 1 9 9 7

0 1 / 0 8 / 1 9 9 8

0 1 / 0 4 / 1 9 9 9

0 1 / 1 2 / 1 9 9 9

0 1 / 0 8 / 2 0 0 0

0 1 / 0 4 / 2 0 0 1

0 1 / 1 2 / 2 0 0 1

0 1 / 0 8 / 2 0 0 2

0 1 / 0 4 / 2 0 0 3

0 1 / 1 2 / 2 0 0 3

0 1 / 0 8 / 2 0 0 4

0 1 / 0 4 / 2 0 0 5

0 1 / 1 2 / 2 0 0 5

0 1 / 0 8 / 2 0 0 6

0 1 / 0 4 / 2 0 0 7

0 1 / 1 2 / 2 0 0 7

0 1 / 0 8 / 2 0 0 8

0 1 / 0 4 / 2 0 0 9

0 1 / 1 2 / 2 0 0 9

0 1 / 0 8 / 2 0 1 0

0 1 / 0 4 / 2 0 1 1

0 1 / 1 2 / 2 0 1 1

0 1 / 0 8 / 2 0 1 2

0 1 / 0 4 / 2 0 1 3

0 1 / 1 2 / 2 0 1 3

0 1 / 0 8 / 2 0 1 4

STRAT

SPX Multi Asset ClassesLong Only

EW Diversification

+ Monthly Rebal.

(2 “free lunches”)

S&P 500 TR

European Equities TR

US 10-year T-Note TR

US REITs TR

Commodities TR

Jan 1995 – Feb 2015 CAGR Ann. St.dev Mod Sharpe

Strategy (blue) 10.08% 6.53% 1.54

SPY (red) 8.52% 15.30% 0.56


20/27

S&P 500 GICS TR using 10-month m.a.


No commissions, no taxes, YES reinvestment when in cash (SHY)

Multi LC US SectorsLong Only

EW + Monthly Rebal.

All 10 S&P 500 sectors TRInvest if above 10-ma

In SHY if below 10-ma

Jan 1992 – Feb 2015 CAGR Ann. St.dev Mod Sharpe

Strategy (blue) 10.74% 8.46% 1.27

SPY TR (red) 7.75% 15.30% 0.51

0

200

400

600

800

1000

1200

D e c - 9 1

D e c - 9 2

D e c - 9 3

D e c - 9 4

D e c - 9 5

D e c - 9 6

D e c - 9 7

D e c - 9 8

D e c - 9 9

D e c - 0 0

D e c - 0 1

D e c - 0 2

D e c - 0 3

D e c - 0 4

D e c - 0 5

D e c - 0 6

D e c - 0 7

D e c - 0 8

D e c - 0 9

D e c - 1 0

D e c - 1 1

D e c - 1 2

D e c - 1 3

D e c - 1 4

STRAT

SPY


21/27

Going Global with Large Cap: Index




22/27

Going Global with Large Cap: 100 stocks


10 MIO USD portfolio: 0.5% commissions, no taxes, no reinv. when in cash


23/27

Bibliography

18 March 2015 Riccardo Ronco +44 20 7233 3245 [email protected] 23

Andreas Clenow - Following the Trend: Diversified Managed Futures

Gary Antonacci – Dual Momentum Investing

Nick Radge – Unholy Grails: A New Road to Wealth

Michael W. Covel - Trend Following: Learn to Make Millions in Up or Down Markets

Michael W. Covel - The Complete Turtle trader: The Legend, the Lessons, the Results

Nick Radge - Unholy Grails - A New Road to Wealth

Curtis Faith - Way of the Turtle: The Secret Methods that Turned Ordinary People into Legendary Traders

Mebane T. Faber - The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets

Anthony Garner - A Practical Guide to ETF Trading Systems: A Systematic Approach to Trading Exchange

Traded Funds

Van K. Tharp - Trade Your Way to Financial Freedom

Edwin Lefevre – Reminiscences of a Stock Operator


24/27

Awards

Riccardo Ronco +44 20 7233 3245 [email protected]


25/27

Legenda


Every week, for several different countries and asset, classes a given set of technical indicators is calculated on specific Equity, Equity sector and Commodity indices. First, we

calculate our proprietary momentum indicator; we then rank the industry groups from best to worst, showing the results for the last six weeks (Friday’s closing prices are used inour calculations). We use the blue color for “Overweight,” the red color for “Underweight,” and no color for “Neutral.”

We prefer to find buy ideas in the top third results of our ranking model, while short ideas are better suited for those indices in the bottom third. This table provide a quick, yeteffective, way to see the dynamics of relative performances in these indices, showing investors’ preferences in the medium term. From an absolute performance point of view,we need to calculate instead the weekly MACD (Moving Average Convergence/Divergence) indicator and its nine-week moving average (the “signal line”).

We technically define a bullish swing as one when the MACD is above its moving average and a bearish swing as one when the MACD is below its moving average. Onthe “Time” column, we count the number of weeks from one swing to the next to gauge the maturity of the current move. When comparing the MACD with its moving averageand with the zero line, however, we can define four phases (Up, Advancing, Down, and Terminating).

The idea is to divide price oscilla tions into clearly identifiable phases (as inspi red by the work of Ian S. Notley) and adjust our risk/reward expectations according to theseindications (see column “Action”, representing the number of weeks a particular index has spent in its bullish or bearish swing phase).

The bullish swing includes the Up and Advancing phases.

Up: The index has bottomed (possibly after showing positive divergences) and is breaking resistance levels. Investors should have a low-risk entry point here. The weeklyMACD is below the zero line but above its signal line. Size should be small at the beginning, and the investor should allow prices to prove themselves.

Advancing: Prices are trending nicely higher with moderate volatility. Approaching the top, we usually see volatility picking up and weekly (daily) ranges increasing. Theweekly MACD is above both the zero line and its signal line. Buying dips can be a rewarding strategy.

The bearish swing includes the Down and Terminating phases.

Down (Declining): The index has built a top (or a congestion phase), and the weekly MACD has crossed from above its signal line. The MACD itself is still above the zeroline here, and the implication is to lighten the position and to use each short-term pullback to reduce/sell the exposure (sell on rallies).

Terminating: Prices are accelerating to the downside, and the weekly MACD is now below both zero and its signal line. Sharp rallies could be confusing, but sticking to thetrend is the best strategy, and investors should generally avoid buying dips here. Volatility is sharply increasing.

EM: Emerging Market.


26/27

Information about technical analysis


This trading idea is based upon technical analysis, which involves the study of historical price and volume trading patterns and the potential direction of future trading basedupon such information. There is no direct or implied guarantee of any particular outcome. This analysis is different from fundamental analysis and the conclusions reached maydiffer. Technical research does not represent a rating or coverage of any discussed issuer(s).

Our daily charts for European and U.S. equities try to highlight in a quick and easy way information about the trend, the relative performance against its benchmark, pricemomentum and accumulation/distribution using volume. Our conviction is clearly a function of these elements and of the time frame used.

To determine the trend we use the classic combination of two moving averages based on a 50 and 200 day length. The trend of the stock will move above and below thesemoving averages and we will look for buy (sell) ideas when price will be above (below) both of them or during mild pullbacks affecting only the 50-day moving averages.

Given two or more signals on stocks in uptrend we use the relative strength versus its benchmark (usually the Eurostoxx 600 for European names and the S&P 500 for U.S.names) to discriminate which one offers the best opportunity for a given signal. Again we like stocks in uptrend with a bullish relative strength as buy candidates.

Momentum (we use the classic MACD Moving Average Convergence Divergence Indicator) tells us where we are in the current phase of the trend. The MACD indicatorrepresents the difference between two moving averages of 12 and 26 days. If this indicator is widening, it confirms the trend in prices is healthy and accelerating. A possibleindication to reduce exposure in a stock that is in uptrend and outperforming is provided either by a short-term trend reversal toward the zero line of this indicator or by anegative divergence between prices and the MACD indicator. New highs in price that are not confirmed by new highs in the MACD, are leading indications that the pace of thetrend is slowing down and a possible reversal is in the offing.

Finally we consider volume in our work in two forms: raw volume represented by a vertical histogram (red for negative trading sessions, blue for positive ones) and the OBVindicator. Raw volume can indicate the underlying structure of buying and selling in the short-term: we like higher price on higher volume and lower prices on lower volume,indicating a positive feedback in investors’ mentality. Spikes in volume are usually associated with climaxes and a short-term reversal is usually the norm. The OBV indicator triesto help to answer the question whether the stock is under accumulation or distribution. The OBV indicator follows prices 95% of the time: we add (subtract) the volume of the dayif the close is positive (or negative) to a running total. A stock that has been for 2-3 months in a tight trading range with an OBV indicator that is breaking higher (lower)provides a leading indication of accumulation (distribution) and helps the investor/trader to be prepare ahead of the breakout in prices.

Aviate Global’s technical rating system has seven categories to differentiate short-, medium-, and long-term time horizons. If there is no rating listed for a stock, Aviate Global isneutral and has no opinion on the stock.

Speculative Buy: A short-term buying opportunity lasting up to one month with projected upside of 10% or more.

Buy: A medium-term buying opportunity lasting up to six months with projected upside of 25% or more.Strong Buy: A long-term buying opportunity lasting more than one year with return potential of 50% or more.Sell Short: A short-term selling opportunity lasting up to one month with projected downside of 10% or more.Take Profit: Immediate closing out of existing position at a profit.Sell/Reduce: Used for a stock with a deteriorating long-term technical outlook that is expected to have a very limited or negative return over the medium to long term.Stop Loss: Immediate closing out of existing position at a loss.

Aviate Global’s technical ratings use specific return targets; returns are not guaranteed and are used for illustrative purposes only.

Chart sources: Bloomberg and Aviate Global LLP.


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TREND Following Mar2016 by Ricardo Ronco

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