One of the oldest technical systems, Gann analysis, assumes a trend is established only if it operates for at least three sessions in succession. Other systems based on moving average (MA) look for a quantum of movement – say, three per cent penetration of the MA being used. Some trend-following systems look for a 20-session high or low as an entry point; others look for a 50-session high or low for an entry.
In each case, the trader is seeking a persistent trend. He is prepared to forgo a considerable profit for the comfort of knowing that a trend is solidly established. He will also set rigid stop-losses and exit points to ensure that he gets out when the trend shows signs of reversal.
As a result, trend-following systems identify relatively few moves as worth trading. Even among those moves, many turn out to be false leads – trends peter out or reverse relatively quickly without major gains. Most trend-following systems have strike rates of 40 per cent or less in that only four (or fewer) positions out of every 10 actually make money.
Given those systematic barriers, any trend-following system relies on making a great deal of money from very few moves. Every so often, the trader hopes to pick up a movement that will persist for months and yield extraordinary profits.
Obviously, this is not a method that translates easily into day trading. Most technical systems can be compressed in terms of time scales. But systems that are designed to eliminate short-term moves and highlight only long-term moves cannot be efficiently compressed. Bluntly, the profit-loss ratios are no longer worth it.
Problems arise for the trend-following methods when trends are choppy or of very short duration. Most trend-following systems depend on a combination of time elapsed and quantum of move. A very short-term trend will not be picked up, even if it’s quite violent. A gentle long-term trend may also escape notice.
For the past several months, the market has been defined by a series of very short-term and violent trends. In effect, the trend has been over before being registered on the radar.
This shows in the results of hedge funds that live by trend-following systems. Quite a few players in the “managed futures” industry, as most of these trend-followers are known, have registered losses during this period.
At the same time, some trends have obviously been established during the period. For example, the stock market is down 21 per cent and the rupee is down 15 per cent. Neither trend seems to have played out. Both could still be open to exploitation.
The author is a technical and equity analyst
