Category: Moving Average

Living with trend following strategies

Trend following approaches, such as Moving Averages and Channels, preserve capital by cutting losses and as such they need sustained bear markets to outperform.

While they will generally capture the bulk of a bull market, the inherent lag means that a trend strategy can never sell at the high of an up move and can end up surrendering significant gains before exiting.

Consequently, outside of bear markets, the best they can do is to be fully invested and match the performance of the benchmark. However, bull market corrections and the short-lived directional moves of sideways markets mean that trend-following methods will inevitably suffer some whipsaw losses.

In other words, lengthy periods of underperformance should be expected in bull and range-bound markets.  For those that can endure these mentally taxing and financially challenging periods, the pay off is the avoidance of major bear market drawdowns.

Below are a pair of backtests, a channel and a moving average, on a simple global 60/40 portfolio (VTI 35%, VGK 10%, VPL 10%, VWO 5%, AGG 30% and TIP 10%).  Examination of the annual returns shows both the strengths and weaknesses of these trend following methods.


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click image to view full size version

Portfolio Channel Backtest
Portfolio Moving Average Backtest

MA, Ratio & Channel Parameter Performance Summaries

We have added three new Parameter Performance Summaries to the website:

As with the Relative Strength and TRD summaries that we introduced in July, each of the above can be accessed from their respective backtests.

Set the min, max and step / increment for each parameter, then click 'Run Backtests' and the tabulated results will be displayed:

Parameter Performance Summaries are available to all (regular and pro) annual subscribers.

**  studying the guidelines that we published within the original Parameter Summaries announcement is highly recommended  **

ETF Backtest Concepts - Relative Strength And The Use of a Moving Average Filter

A video using ETFreplay Backtesting to look at some relative strength concepts and a moving average filter (daily).


to expand video on screen, click the '4 expanding arrows' icon in the bottom right corner of the video screen


Backtesting: Combining Relative Strength With A Moving Average Filter

We have added an optional moving average (MA) filter feature to the RS backtest app.  With the recently expanded date start and stop functionality, the applications continue to get more versatile.  

Combining a long-term moving average within the construct of relative strength has been highly requested and we wanted to discuss one idea when considering whether to use it (note that you can just leave it set to ‘off’ as well).  

If you build a relative strength list of say 10 ETFs and you are choosing the top 2,  you could protect your portfolio by including 2 bond funds.   You don’t need a moving average filter because the bond funds will naturally be the ones with the relative strength when equity markets are dropping.   This method actually can get more interesting because you can make better use of more type of ETFs.   Rather than just use cash-like bond funds, you might want to extend the potential holdings to an intermediate bond fund like IEF (7-8 year duration) or others. You don't HAVE to restrict yourself to just stocks and cash.   

Another way to test is by using a moving average.   If you do it this way, then you will inherently be out of ETFs as they go into extended downtrends.  You don’t have to proportionally keep X number of bond funds in your list if you do it this way.    

But a lot of indexes can go above or below a long-term moving average and still not really be a source of market leadership and enhance your return.   Moreover, you may save a lot of money between the time ETFs lose relative strength and the time they actually cross below the moving average.   For these reasons, we believe adding relative strength to a MA strategy will generally be more robust.   Adding MA to a RS strategy is optional -- and you may find works better or worse than your existing method.   Continuous testing leads to better decisions.


Moving Average ETF Backtest For Portfolios

If you have created a portfolio list on ETFreplay, we are building new applications to leverage your ETF lists.

We have two new modules out that we have been working on for the past few months.  These applications offer simplified views to help us try to understand larger forces at work in the global marketplace.  

Building upon academic research regarding the use of moving averages, these apps save investors time by allowing many calculations and quantitative analyses to be simplified into a few clicks.  We think that creating specific entry/exit rules and creating a detailed strategy report adds value to better understanding a concept. That is, we create apps that convert concepts into tangible, specific techniques.  The accountability of these techniques is built into the very architecture of the website. On any day, you are just a click away from an updated view of the profit and loss history of a particular strategy.

Importantly, this type of research should be used as a complement to other forms of research. We suggest you think about which types of ETFs you want to be involved with over the long-run and then use techniques such as relative strength and moving average backtesting to help you research methods that reduce risk of a large drawdown, while potentially offering to enhance your return as well.


The example below uses 4 key smaller developed markets outside Europe & the U.S.

1.  EWA   iShares MSCI Australia Index
2.  EWC   iShares MSCI Canada Index
3.  EWH   iShares MSCI Hong Kong Index
4.  EWS   iShares MSCI Singapore Index