Trend Trading Research

Relative return is a measure of an investment relative to a benchmark.

For example a UK based equity fund may measure it’s return relative to the FTSE 100 or FTSE All Share index. When the relative return is positive, the investment has outperformed the benchmark, conversely when the relative return is negative the investment has underperformed the benchmark.

Although the relative return is widely used to market various investment funds, investors need to exercise care, as fund may well outperform the benchmark but still loose them money. For example in a falling market the index may fall by 20%, if the investment falls by just 10% it will have outperformed the market and provided a positive relative return of 10% despite loosing 10% of the capital invested (thus the absolute return would be -10%).

An investor hoping to achieve a positive absolute return, no matter what the market conditions would need to use an absolute return strategy or invest in a fund that does so.

The absolute return, or more simply the return is the measure of the profit or loss of an investment expressed as a percentage. the term absolute is used to differentiate the measure from the relative return.

An absolute return strategy aims to produce a positive return on an investment regardless of the underlying market conditions.

Most hedge funds employ absolute return strategies. There are also a number of absolute return funds using absolute return strategies.

Exchange-Traded Funds (ETFs – read the article What Is An ETF if you don’t know what they are) seem to be ideal for trend trading.

Firstly, as Curtis Faith argues in the book Way Of The Turtle, trend following is best suited to either: fundamentals-driven markets such as currencies or interest rates; or speculator-driven markets such as stocks and futures. ETFs can be used to track stock market indexes which fits neatly into the second category.

Secondly unlike managed index funds there is generally no management charge as there is very little to manage. Additionally you can trade ETFs for roughly the same fees as it will cost you to trade the shares themselves – in contrast most funds will charge you and entry and exit fee.

Thirdly, it is possible to purchase a short ETF allowing traders to benefit from a downwards trend as well as upwards trend.

Finally, ETFs also have several potential tax advantages:ETFs do not incur stamp duty; and you can  trade ETFs as part of an ISA or SIPP making the trades entirely tax-free.

As I kick of my trend trading research I know relatively little about trend trading and technical analysis so I’ve had a browse through Amazon’s site and ordered some books to get me started, they are:

• Way of the Turtle: The Secret Methods that Turned Ordinary People into Legendary Traders by Curtis Faith – A book by one of trading guru Richard Dennis’s ‘Turtles’ explaining the experiment and their trend trading strategies.
• Trend Following: Learn to Make Millions in Up or Down Markets by Michael W. Covel – An introduction to the principles of the trend following trading philosophy and its multiple aspects: discipline, drawdowns, risk and money management, behavioural biases, prediction vs. reaction, etc.
• Getting Started in Technical Analysis by Jack D. Schwager – described as a good introductory book for those of us who know relatively little (or nothing) about technical analysis.

Additionally I’ve ordered:

• A Random Walk Down Wall Street: The Time-tested Strategy for Successful Investing by BG Malkiel – Argues that the stock market is random and due the the efficient markets hypothesis it is impossible to out-perform the market on a consistent basis.
• Inefficient Markets: An Introduction to Behavioural Finance by Andrei Schleifer – It seems that the relatively new field of behavioural finance questions the validity of the efficient markets hypothesis and my offer some insight in the viability of trend trading strategies.

I’ve also read Richard Farleigh’s Taming the Lion: 100 Secret Strategies for Investing which is the book that inspired me to research trend trading.

An Exchange-Traded Fund (ETF) is an investment fund that is traded on a stock exchange. The ETF holds assets such as stocks, commodities, or bonds and trades at the net asset value of the underlying assets. Most ETF’s track an index, i.e. the FTSE 100. ETF’s achieve this by holding either the contents of the index or a representative sample of the index in their portfolio, in an attempt to replicate the performance of the index. Some ETF’s track commodity indexes, these are sometimes referred to as Exchange-Traded Commodities (ETCs). Likewise some invest solely in bonds and are known as bond ETFs.

ETFs are liquid investments allowing investors to be able to easily sell their shares during normal market hours. The dividends collected from the ETF’s portfolio (in the case of stock based ETFs) are usually distributed to the investors at regular intervals and ETF management fees are usually deducted from the dividends.

ETFs can be traded through most stock brokers for roughly the same cost as trading directly in the underlying assets.

Welcome to Trend Trading Research. On this blog I’ll be documenting my research into the various trend trading strategies and testing both the assumptions and theories on which they are based and the strategies themselves using historical data.