MTA 2015 October London FINAL

TREND
FOLLOWING
Problems (and possible solutions)
for application to equities
October 2015 – London
Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com 2
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Riccardo Ronco, CFTe
Biography
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 and
foreign 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 identifying
reversal patterns characterized by excessive consensus among investors.
Mr. Ronco brings more than 15 years of experience in trading, quantitative analysis, and teaching
technical analysis in the United Kingdom and Ialy. 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 the
Society of Technical Analysts (STA) from 2000 to 2015 and the Market Technicians Association
(MTA), Mr. Ronco was a speaker at the International Federation of Technical Analysts (IFTA) 1998
conference in Rome, in Beijing (2011) and in New York for the MTA 2015 Symposium.
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 the
University of Turin.
He currently holds Chartered Market Technician (CMT) Level 1 and 2 diplomas.

Awards
Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

Behavioral Basis for Trends

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

From David Ricardo (1772-1823) to Ed Seykota
“The Great Metropolis”, Vol II, 1838, James Grant

Problem nr 1: FEEDBACK CHANGES
•Markets alternate phases of positive feedback with phases of negative feedback
•Positive feedback: investors/traders BUY into STRENGTH and SELL into WEAKNESS
•Negative feedback: investors/traders SELL into STRENGTH and BUY into WEAKNESS
•Investors’ capital is always moving between LEADERS and LAGGARDS
•Simple RELATIVE STRENGTH is a major tool to help spotting LEADERS and LAGGARDS
•Ranking is another major tool to keep focus on these two sets of stocks
Important paper : Asness, Moskowitz and Pedersen (2008), “Value and Momentum Everywhere”
Important book : Gary Edwin Anderson (2012), “The Janus Factor”

TREND + RS ---> LEADERS LAGGARDS

Things are not so simple
Ideally, as a trend follower, all you want to do is:
•...Buy BREAKOUTS in the strongest stocks in the strongest countries and
•...Sell BREAKDOWNS in the weakest stocks in the weakest countries
In REALITY, it depends on the CONTEXT, the environment
IMPORTANT QUESTION
“are we in a TREND FOLLOWING/HIGH
MOMENTUM environment or in a MEAN-
REVERSION/LOW MOMENTUM environment?”

Momentum Crashes
•RANKING stocks on a 12 –month basis
•Holding for one month (long only), no transaction costs
•Creating 10 portfolios for each decile (10 best/winner – 1 worst/loser)
•60-year period 1947-2006 comparing leaders, laggards, cash and B&H
Important paper
Daniel, Moskowitz (2013), “Momentum Crashes”

LEADERS vs LAGGARDS
Momentum Components, 1947-2006
Over the 60-year period from 1947:01 through 2006:12
Cumulative returns for four assets: (1) the risk-free asset; (2) the CRSP value-weighted index; (3) the bottom decile “past loser”
portfolio; and (4) the top decile “past winner” portfolio. Initial capital $1 in January 1947
Source: Daniel, Moskowitz (2013), “Momentum Crashes” CRSP = Center for Research in Security Prices

Momentum Crashes
Momentum Components, 1947-2006
Result of a LONG WINNER SHORT LOSER portfolio

Momentum Crashes
14Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com
momentum strategy suffers its worst performance at “turning points,”
following large market declines
•June 1932, the market bottoms...
•in July-August 1932, the market rose by 82% but...
•... losers outperform winners by 206% (L +236%, W+30%)
•March 9, 2009, S&P 500 bottoms @ 666.79...
•In March-May 2009, the market has a violent rally of 40%
•...losers outperform winners by 149% (L +156%, W +6.5%)

Momentum Crashes: 1930s
Result of a LONG WINNER SHORT LOSER portfolio

Momentum Crashes: March 2009
Comparing Winners / Losers / Stock Market
Here we are using the Dow Jones U.S. Thematic Indices (Attention: RESULTS are DIFFERENT FROM CRSP data)
https://www.djindexes.com/mdsidx/downloads/meth_info/Dow_Jones_US_Thematic_Neutral_Indices_Methodology.pdf

Momentum Crashes: Nov 2002
Comparing Winners / Losers / Stock Market
Using Dow Jones U.S. Thematic Indices (Attention: RESULTS are DIFFERENT FROM CRSP data)
https://www.djindexes.com/mdsidx/downloads/meth_info/Dow_Jones_US_Thematic_Neutral_Indices_Methodology.pdf

Point of View of a Trend Follower
“Those were the lean years, 1911-1914. The market flattened out. Things drifted from bad to worse. I
not only lost all I had but got into debt again. There was no money to be made.”
Jesse Livermore, Reminiscences of a Stock Operator(Lefevre)

POSSIBLE SOLUTION
“In some seasons trend following is good; in others, reversing is good.
The problem is how to differentiate the two seasons in advance.”
Victor Niederhoffer, The Education of a Speculator
CALCULATE AND PLOT THE HIGH/LOW MOMENTUM RATIO
In an attempt to qualify what kind of environment we are in
•a RISING ratio indicates POSITIVE feedback (MOM beats MR): use TF
•a DECLINING ratio indicates NEGATIVE feedback (MR beats MOM): be a “contrarian”

S&P EW vs High/Low Momentum Ratio
In a bull market we can see the alternation between MOM phases (bullish ratio) and
MR phases (bearish ratio) regardless of countertrend moves in the main trend

Bull markets start with “junk” rallies
Bear markets start with the sale of recently bought laggards – weak hands

Bull markets alternate MR vs MOM for long periods of time
Bear markets are mostly MOM (bearish) affairs with MR rallies

Alternative: MTUM (Hi Mom Long) / SPY ratio

DJ Stoxx 600: EU MOM vs SXXR (TR)
MSCI Europe Momentum Net EUR Index: MAEUMMT Index on Bloomberg
DJ Stoxx 600 Total Return: SXXR Index on Bloomberg

Problem nr 2: Optimization (choice of parameters)
No commissions, no taxes, no reinvestment when in cash
10
100
1000
10000
100000
01/09/1928
01/06/1931
01/03/1934
01/12/1936
01/09/1939
01/06/1942
01/03/1945
01/12/1947
01/09/1950
01/06/1953
01/03/1956
01/12/1958
01/09/1961
01/06/1964
01/03/1967
01/12/1969
01/09/1972
01/06/1975
01/03/1978
01/12/1980
01/09/1983
01/06/1986
01/03/1989
01/12/1991
01/09/1994
01/06/1997
01/03/2000
01/12/2002
01/09/2005
01/06/2008
01/03/2011
01/12/2013
S&P 500 MA
B&H

Trade them all! (and play with weights)

From Bullish/Bearish to How MUCH Bullish...

ROBUST TF: Multi-Average + Reinvesting
No commissions, no taxes, YES reinvestment
100
1000
01/11/1992
01/08/1993
01/05/1994
01/02/1995
01/11/1995
01/08/1996
01/05/1997
01/02/1998
01/11/1998
01/08/1999
01/05/2000
01/02/2001
01/11/2001
01/08/2002
01/05/2003
01/02/2004
01/11/2004
01/08/2005
01/05/2006
01/02/2007
01/11/2007
01/08/2008
01/05/2009
01/02/2010
01/11/2010
01/08/2011
01/05/2012
01/02/2013
01/11/2013
01/08/2014
01/05/2015
B&H
12M
9M
6M
3M
ALL
Invested in SPY if above 3, 6, 9, 12 or all averages (25% each) or in IEF (US 10-year)
Pfolio CAGR%
B&H 8.9%
12 M 12%
9 M 13.13%
6 M 12.50%
3 M 9.28%
ALL M 11.92%

Problem nr 3: Reducing Risk in Bear Markets
No commissions, no taxes, NO reinvestment when in cash

Going Global with Large Cap: 100 stocks
10 MIO USD portfolio: 0.5% commissions, no taxes, no reinv. when in cash

Running 10-month MA on FTSE 100 (long only)

10-month filter on stocks AND Index (at entry)

Bibliography
16 October 2015 Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com 33
Gary Edwin Anderson – The Janus Factor: Trend Follower’s Guide to Market Dialectics
Andreas Clenow - Following the Trend: Diversified Managed Futures
Andreas Clenow – Stocks on the Move: Beating the Market with Hedge Fund Momentum Strategies
A. Greyserman, K. Kaminski – Trend Following with Managed Future: the search for crisis alpha
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
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

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 in
our 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, yet
effective, 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. On
the “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 average
and with the zero line, however, we can define four phases (Up, Advancing, Down, and Terminating).
The idea is to divide price oscillations into clearly identifiable phases (as inspired by the work of Ian S. Notley) and adjust our risk/reward expectations according to these
indications (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 weekly
MACD 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. The
weekly 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 zero
line 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 the
trend is the best strategy, and investors should generally avoid buying dips here. Volatility is sharply increasing.
EM: Emerging Market.

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 based
upon such information. There is no direct or implied guarantee of any particular outcome. This analysis is different from fundamental analysis and the conclusions reached may
differ. 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, price
momentum 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 these
moving 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 indicator
represents 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 possible
indication 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 a
negative 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 the
trend 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 OBV
indicator. 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 tries
to 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 day
if 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 is
neutral 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.

Global Disclaimer
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This note is circulated to you as a client of Aviate Global LLP. Please note that the views contained within may have been disclosed earlier today to some clients via Bloomberg. If you would like
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MTA 2015 October London FINAL

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