Follow Trends
First let’s talk about what following trends means and what following trends does not mean.
Following Trends by definition is an investment strategy that takes advantage of long-term positive and negative moves that play out in the financial markets. A trend following strategy will have a particular metric or a series of metrics that trigger buying and / or selling. At Sustainable Investment Strategies we do not attempt to guess the direction of the market. For us, the goal of following trends, is to be invested in the positive trends in the market and sitting out of the negative trends in the market.
Trend following is not a buy and hold strategy nor is it market timing.
Buy and Hold is an investment strategy that is exactly as it sounds you buy an asset and hold through ups and downs in the market. Recent history (late 1990’s through the present) has shown that long stretches of time can go by and your portfolio can rise and fall many times only to leave you in the same place you started many years before. Buy and hold should be seriously reconsidered.
Market Timing is defined by the website investorwords.com as “Attempting to predict future market directions, usually by examining recent price and volume data or economic data, and investing based on those predictions.”
What is the benefit of following trends?
The single biggest mistake the average investor and professional investors make is letting emotion get involved in the investing process. A trend following investment strategy removes emotion and the urge to time the market and puts in its place a disciplined set of metrics for buying and selling. The metrics answer the following questions all investors share:
- How and when to enter the market
- How much to buy
- When to exit if the position is unprofitable
- When to exit if the position is profitable
The second benefit is being out of the market for most if not all of down market trends. Most investors look to get as much of the upside of the market as possible. Why? The media and the financial services industry have conditioned the public and itself that beating the broad market indexes is paramount. While it is nice to beat the broad market indexes in the good years it is more important to not lose as much in the bad years.
Graphical Comparison
Click on the graph image below to open a 2 page PDF file comparing a buy and hold strategy and a simple trend following strategy. The graph outlines the following:
- A buy and hold strategy assuming the purchase of 200 shares of the Vanguard S&P 500 Index fund (VFINX) on 1/3/1989 with all dividends and capital gains reinvested.
- A trend following strategy assuming the purchase of 200 shares of the Vanguard S&P 500 Index fund (VFINX) on 1/3/1989 with all dividends and capital gains reinvested. It also assumes that shares are only held if VFINX is above its 200 day exponential moving average (EMA). If the fund is below the 200 day EMA shares are sold and held in cash.
The first page of the PDF file below is a graph of the performance of the two scenarios and the second page is the annual returns and statistics of both scenarios. Enjoy!
