Investing with the trend: a rules-based approach to money management

Investing with the Trend: A Rules-Based Approach to Money Management......Page 5
Copyright......Page 6
Contents......Page 9
Foreword......Page 11
Preface......Page 13
Acknowledgments......Page 17
 Believable Misinformation......Page 19
 Indicators and Terminology You Should Be Familiar with......Page 22
 Living in the Noise......Page 27
 Data......Page 28
Part I: Market Fiction, Flaws, and Facts......Page 31
  The Void of Accountability......Page 33
  Hiding behind Statistics......Page 34
  You Must Remain Invested or You Will Miss the 10 Best Days of the Year......Page 35
  Diversification Will Protect You?......Page 36
  Dollar Cost Averaging......Page 39
  Compounding Is the Eighth Wonder of the World......Page 41
  Relative Performance......Page 42
 Chapter 3: Flaws in Modern Financial Theory......Page 45
   Black Monday, October 19, 1987......Page 46
   Tails Wagging the Dog......Page 47
  Standard Deviation (Sigma) and Its Shortcomings......Page 49
  High Sigma Days We All Remember......Page 52
  Rolling Returns and Gaussian Statistics......Page 53
  Risk and Uncertainty......Page 60
  Back to the Original Question: Is Volatility Risk?......Page 61
  Is Linear Analysis Good Enough?......Page 62
  Linear Regression Must Have Correlation......Page 63
  The 60/40 Myth Exposed......Page 65
  Discounted Cash Flow Model......Page 67
  The Deception of Average......Page 69
  Everything on Four Legs Is a Pig......Page 73
 Chapter 5: The Illusion of Forecasting......Page 75
  The Reign of Error......Page 77
  An Investment Professional’s Dilemma......Page 79
  Gurus/Experts......Page 81
  Masking an Intellectual Void......Page 83
  Earnings Season......Page 84
  Are Financial Advisors Worth 1 Percent of AUM (Assets under Management)?......Page 85
  News Is Noise......Page 86
  Behavioral Investing......Page 89
   Anchoring......Page 90
   Communal Reinforcement......Page 91
   Halo Effect......Page 92
   Loss Aversion/Risk Aversion......Page 93
   Prospect Theory......Page 94
   Self-Attribution......Page 95
  Bias Tracks for Investors......Page 96
  Investors as a Whole Do Poorly......Page 97
  Stock Exchange Holidays......Page 101
  Bull Markets......Page 102
  Bear Markets......Page 104
  Just How Bad Can a Bear Market Be?......Page 108
  Bear Markets and Withdrawals......Page 110
  Market Volatility......Page 114
  Dispersion of Prices......Page 119
  Secular Markets......Page 121
  Secular Bull Markets......Page 124
   Secular Bull Markets since 1900......Page 125
   Secular Bull Market Composite......Page 126
   Secular Bear Markets since 1900......Page 127
   Secular Bear Market Composite......Page 128
   The Last Secular Bear Market (1966–1982)......Page 129
  Market Valuations......Page 131
   Secular Bear Valuation......Page 132
   Secular Bull Valuation Composite......Page 134
  Market Sectors......Page 136
  Sector Rotation in 3-D......Page 140
  Asset Classes......Page 142
  The Lost Decade......Page 143
  Market Returns......Page 148
  Distribution of Returns......Page 152
Part II: Market Research......Page 157
 Chapter 9: Why Technical Analysis?......Page 159
  I Use Technical Analysis Because . . .......Page 161
  The Challenge of Technical Analysis......Page 162
  Technical Indicators......Page 165
  Some Things That Bother Me......Page 166
   Bold Statements about an Indicator’s Value/Worth......Page 167
   Fibonacci Numbers......Page 168
   Reversal and Continuation Patterns......Page 169
   Japanese Candle Patterns......Page 170
   Support and Resistance......Page 171
   Multicollinearity......Page 172
   Polls and Surveys......Page 173
   Miscellaneous......Page 174
  Supply and Demand......Page 177
  What Do You Know about This Chart?......Page 178
  Trend versus Mean Reversion......Page 180
  Trend Analysis......Page 181
   Trendiness Determination Method One......Page 190
   Trendiness Determination Method Two......Page 191
   Comparison of the Two Trendiness Methods......Page 194
   Comparison of Trendiness One Rank and Trendless Rank......Page 198
   Trend Table Selective Analysis......Page 202
  Indices Analysis Summary......Page 210
   Sector Trendiness......Page 214
   Data with History Prior to 1980......Page 223
   GICS Total Summary......Page 232
   GICS Summary Table (With Inadequate Periods of Analysis Removed) GICS Table for All Trends Up to and Including 30 Days......Page 241
  Trend Analysis in Secular Bear Markets......Page 248
  Drawdown Terminology......Page 249
  Cumulative Drawdown......Page 251
  S&P 500 Drawdown Analysis......Page 253
   Drawdown Decline—S&P 500......Page 254
   Drawdown Duration—S&P 500......Page 255
   The Drawdown Message—S&P 500......Page 256
   Alternative Method......Page 257
   Distribution of Drawdowns—S&P 500......Page 258
   S&P 500 Index Excluding the 1929 Bear Market......Page 260
   Drawdowns Greater than 20 Percent Are Bear Markets......Page 262
   Drawdown Recovery—S&P Total Return......Page 265
   Drawdown Duration—S&P Total Return......Page 266
   Distribution of All Drawdowns—S&P Total Return......Page 267
   Bear Markets—S&P Total Return......Page 268
   Drawdown Decline—Dow Jones Industrial Average......Page 269
   The Drawdown Message—Dow Jones Industrial Average......Page 270
   Average Drawdown—Dow Jones Industrial Average......Page 271
   Distribution of Drawdowns—Dow Jones Industrial Average......Page 272
   Dow Industrials Excluding the 1929 Bear Market......Page 273
   Drawdowns Greater than 20 Percent Are Bear Markets......Page 275
   Drawdown Recovery—Dow Industrials Total Return......Page 276
   Distribution of Drawdowns—Dow Industrials Total Return......Page 278
   Bear Markets for Dow Industrials Total Return......Page 279
  Copper Drawdown......Page 280
  Drawdown Intensity Evaluator (DIE)......Page 282
Part III: Rules-Based Money Management......Page 285
  Moving Averages and Smoothing......Page 287
   Simple or Arithmetic Moving Average......Page 288
   Exponential Moving Average......Page 289
  Stochastics......Page 291
  RSI (Relative Strength Index)......Page 292
  Moving Average Convergence Divergence (MACD)......Page 293
  The Binary Indicator......Page 295
  How Compound Measures Work......Page 297
  Weight of the Evidence Measures......Page 299
  Indicator Evaluation Periods......Page 301
  Price-Based Indicators......Page 302
   Price Long Term......Page 303
   Adaptive Trend......Page 307
   Advances/Declines......Page 309
   Up Volume/Down Volume......Page 310
   New Highs/New Lows......Page 312
   Breadth Combination Measure......Page 313
   Breadth Is Not Always Internal Data......Page 314
  World Market Climate......Page 315
  Cyclical Market Measure......Page 317
   Small Cap versus Large Cap Component......Page 318
   Breadth versus Price Component......Page 319
   Relative Strength Compound Measure......Page 320
  Dominant Index......Page 321
   Advance Decline Component......Page 323
   Trend Capturing Compound Measure......Page 324
  LTM—Long-Term Measure......Page 326
  Bull Market Confirmation Measure......Page 327
  Initial Trend Measures (ITM)......Page 329
   Mega Trend Plus......Page 332
   Trend Strength......Page 333
  Ranking Measures......Page 337
   Trend......Page 338
   Trend Rate of Change (ROC)......Page 339
   Trend Diffusion......Page 340
   Price Performance......Page 342
   Relative Performance......Page 344
   Power Score......Page 345
   Efficiency Ratio......Page 346
   Average Drawdown......Page 348
   Price × Volume......Page 349
   Weighted Performance......Page 351
   Sortino Ratio......Page 352
   Relationship to Moving Average......Page 354
   Correlation......Page 356
  Pullback Rally Analysis......Page 357
  Pair Analysis......Page 360
   Tie-Breaker Measures......Page 364
  Rules and Guidelines......Page 365
   Buy Rules......Page 368
   Trade Up Rules......Page 369
   Guidelines......Page 370
  Asset Commitment Tables......Page 371
 Chapter 15: Putting It All Together: The “Dancing with the Trend” Model......Page 373
  Weight of the Evidence......Page 374
  Investing with the Weight of the Evidence......Page 379
  Discipline......Page 381
  Tweaking the Model......Page 382
  Model in Action......Page 383
   Sharpe Ratio......Page 385
   Up and Down Capture......Page 386
   Whipsaws......Page 387
   Stops and Stop Loss Protection......Page 388
   Stop Loss Execution......Page 389
  Mutual Fund Expenses......Page 390
  Benchmarking......Page 391
  Actual Results from a Rules-Based Trend-Following Strategy—Dancing with the Trend......Page 392
   Dance with the Trend Performance and Risk Comparison......Page 393
   Dance with the Trend over a Full Market Cycle......Page 395
   Dance with the Trend Comparison with Style/Asset Classes......Page 402
   Dance with the Trend Performance Comparison......Page 404
  Mean Shifting......Page 407
 Chapter 16: Putting Trend-Following to Work......Page 409
 Chapter 17: Conclusions......Page 417
  Financial Advice......Page 418
   Robert Farrell’s 10 Rules for Investing......Page 419
   James Montier (GMO)......Page 420
  Secular Markets and the Efficiency Ratio......Page 421
  The Rules-Based Trend-Following Model in October 1987......Page 422
  The Flash Crash of May 6, 2010......Page 423
  Final Observations......Page 424
Appendix A: Passive versus Active Management......Page 427
Appendix B: Trend Analysis Tables......Page 431
 Why Breadth?......Page 463
 Breadth Components......Page 464
 Breadth versus Price......Page 465
 The Difference between Daily and Weekly Breadth Data......Page 466
 Advantages and Disadvantages of Using Breadth......Page 467
 New High New Low Validation Measure......Page 472
 Additional Recommended Reading......Page 475
Bibliography......Page 477
About the Author......Page 485
About the Online Resources......Page 487
Index......Page 489