The Dow Jones Industrial Average:
A Long and Profitable History of Booms and Busts
3. Trend-following helps you ignore the short-term noise in the markets.
"The stock market is like an excitable dog on a very long leash
in New York City, darting randomly in every direction. The dog’s owner
is walking from Columbus Circle, through Central Park,to the Metropolitan
At any moment, there is no predicting which way the pooch will
lurch. But in the long run, you know the dog is heading northeast at an
average speed of three miles per hour. What is astonishing is that
almost all of the market players, big and small, seem to have their eye
on the dog, and not the owner."
Whether you are investing in the stock market or some other asset class,
trend-followers are focusing on the owner – and not the dog. In doing so they act on what’s important (the trend) and not on what’s entertainment. It’s easy to say you should ignore the day-to-day noise in the markets, but this is very hard to do because we are bombarded with information in today’s world.
4. Who’s good at market forecasts? Almost no one.
Even though EVERYONE has an opinion (myself included) on where the markets are heading, no one can successfully predict what is going to happen tomorrow – let alone the next few months or even years – on a consistent basis.
A 2012 study by BlackRock –
who is the world’s largest asset
manager with over $4.6 trillion
under management – showed that
the average investor generated a
measly 2.1% annual return in the
markets over the period from
Since investors typically benchmark their performance against the
S&P 500 – which averaged 7.7% per year during the 20 year study period –
a 2.1% average annual return is clearly an extraordinary amount of under-performance.
Trend-followers, however, are grounded in reality. They refuse to speculate about which way the markets will go and deal with facts only. The timing model that I developed for U.S. housing markets – which is driven entirely by hard monthly data – helped real estate trend-followers correctly exit the California home market in 2006 and avoid the 40-50% price collapse that followed.
Trend-following – while less than perfect – still remains the best and most objective way to measure which way the markets are likely to move in the future.
Key point: Trend followers don’t try to predict the future. They take what the market offers them in the present.
5. Ignore your ego. The market is always right and you aren’t.
Ego is the enemy of successful investment. What you need is objectivity.
As I write in Timing the Real Estate Market:
"When the markets change, your success as an investor will
revolve around being flexible, open-minded, and willing to go with
the market’s flow.
Until you let go of the false idea that you – or anybody else –
knows more than the market does, you will be building up your ego
instead of your bank account."
Also from Timing the Real Estate Market:
"Don’t take this personally … but what you believe – or what
someone else believes – is irrelevant to correctly identifying the trend
of any given asset class.
That’s because the market will always move in the direction of
the greatest force. Therefore, when buyers are a greater force than
sellers, prices will rise. When sellers are a greater force, prices will fall.
This simple, mechanical principle of cause and effect will always
rule the markets – regardless what anyone believes to the contrary."
Most investors tend to focus more on the short-term behavior of the markets (often called “noise”) than they do the longer-term primary trends.
Ralph Wanger, the eccentric portfolio manager of
the Acorn Fund, once summed up investing in the stock market like this:
Now more than ever you can see these opinions expressed in real-time on 24 hour financial news networks, finance websites, blogs, and Twitter.
Many people thought the U.S. housing market was in a bubble in 2006-07, yet the forecasts expressed by most real estate analysts did not include even a year-over-year fall in nationwide housing prices – let alone a 35% collapse - for the simple reason that we hadn’t seen an event like that since the end of WWII.
After spending years studying profitable trend-following strategies, I found that there are many that tend to outperform buy-and-hold strategies – and I personally employ several of them. The two I will be discussing in this report are called “The Best Investment Strategy I’ve Seen in 30 Years” and the “Dare To Be Great Investment Strategy.”
[Note: While both of these trend-following strategies invest in the same diversified asset classes, Strategy #3 is a high-performance version of Strategy #2 – where risk has been dialed up for the opportunity to earn higher returns.]
For the test period between 1973 and 2008, the table below shows how these two strategies have performed against a buy-and-hold strategy for the S&P 500.
If you started investing in the DJIA in 1924, you would have been loving life. You made a 200% gain on your money during the next 5 years.
But the trend is your friend until it isn’t.
If you were unlucky enough to start investing in 1929, you lost 89% of your money during the next 3 years – and you had to wait until 1954 to get back to break-even.
While the 1929 stock market crash was the worst in U.S. history, there have also been a number of other devastating market crashes that have occurred since that time.
In 1974, the DJIA fell 40%, and it took over six years to recover. But market volatility has increased in the last 15 years. In 2000-2002 and again in 2007-2009, the DJIA dropped 39% and 54% from peak to trough – and you had to wait between 5 to 8 years to recover your initial investment.
Risk vs. Reward
The above examples show that in order to reap the benefits of average returns of 9-10% or so per year, buy-and-hold stock market investors must be willing to accept the risk of losing more than half their capital from time to time.
With that kind of market volatility and equity drawdowns, how many investors are emotionally prepared to do this? How many are willing to patiently stick with stocks for extended periods of time after losing 50% of their money?
My guess is not many – and this is especially true if you are in or near retirement! Because this is more risk that most investors can bear, I feel that the use of well-designed trend-following strategies is a superior way to invest.
Also know that because of fear and greed, there is a strong propensity for investors to buy near market highs and sell near market bottoms – and the greater the volatility, the more pronounced the effect. A rule-based trend-following strategy will not only help investors overcome this human weakness – but it can also help you out-perform a buy-and-hold strategy in the long run.
The bottom line is this: If you are going to invest, you might as well use the best and most profitable strategies that are available to you – and as I will now show you, that’s what I try to do for my clients and real estate Timing Letter subscribers.
From the first time I became interested in stocks as a teenager, I was never able to accept the boiler-plate advice that buying-and-holding is the best way to invest – and that there is no alternative but to accept heavy losses during severe market downturns.
Yes, You Should Read This
“There is only one side to the markets and it’s
not the bull side or the bear side, but the right side.”
– Jesse Livermore
“Why I’m a Trend-Follower –
And Not a Buy-And-Hold Investor”
PS: What will be the next big moves in the markets?
No one can know for sure, however there is strong evidence that another 2007-2008 debt-driven economic storm lies ahead.
To prepare for such an event, that’s why I’m putting on a series of seminars titled: “Buckle Up! Why an Economic Storm Lies Ahead.”
We don’t know whether the current debt (and unfunded government liability) crisis will be resolved via inflation or deflation (default) – or some combination of both. But when the new storm strikes, the chain reaction of events could once again be devastating for investors.
When the chain reaction happens – as it always does – it will be critical that you be in the right asset classes at the right time.
If you use “The Best Investment Strategy
it’s my view that trend followers that move money
into and out of a diversified group of well-selected asset classes will likely be the big winners.
to identify medium-to-long term trends that are typically caused by real economic developments – and then to methodically make money from those trends over time.
The concept of the trend following is not complicated or difficult to understand. In the strategies I use, it's nothing more than a statistical method used
The average holding period for both strategies range between 6-10 months, which not only makes them highly usable for private investors, but as is the case with the method I present in my book for successfully timing real estate markets, it shows that even simple trend-following strategies that require minimal involvement (like 45-60 minutes or so every month) can perform remarkably well over time.
Why does performance improve when trend-following is applied? The reason is because both Strategy #2 and Strategy #3 share these two important elements:
• Risk diversification among the major asset classes;
• Risk management. While it is impossible to consistently time the
highs and lows of any asset market, you can achieve greater levels of gain
over loss with the right trend-following strategies.
Trend Following in a Nutshell
1. When you get the timing wrong,
location, location, location is of no use.
2. When you get the timing right,
location, location, location is of no need.
Robert M. Campbell
Why does the average investor do so poorly? According to psychologist Daniel Kahneman, who won a Nobel Prize in 2002 for his work on behavioral economics, “It’s because the long term is not where life is lived."
Driven by the short-term emotions of fear, greed, and hope – the average investor makes ill-timed buying and selling decisions. Instead of buying low and selling high – the above chart shows that he tends to do just the opposite.
Key point: Trend-following takes a more objective, rational and longer-term approach – and takes day-to-day emotions out of the decision-making process.
In the world of mainstream financial advice, we’ve always been told the best way to invest is to buy-and-hold for the long term. You should just buy the S&P 500 index, stay invested through good markets and bad, and that years later you will walk away with huge gains.
The argument is that over a long period of time, it doesn’t really matter when you get in and get out. Stocks always go up in the long run and you will therefore always make money.
This may sound very reasonable and make for a good sales pitch – but once you understand the true price of those returns in terms of volatility, drawdowns and long periods of sleepless nights, the strategy of simply buying and holding stocks (or any other asset class) for decades does not make much sense to me.
A trend following strategy, however, is based on the premise that you do NOT have to be invested in the markets all the time. Even though I knew that the market was hard to beat, after reading the Market Wizard books by Jack Schwager, I learned that is was not impossible to do so.
With respect to the trend following strategies that I use, there has been research (Geczy and Samonov – 2012) showing their superiority to buy and hold investing going all the way back to the year 1801. While we all know that there is no Holy Grail (or sure-fire formulas) for always making money in the markets and never losing it – trend followers are generally on the right side of big moves.
That’s why Geczy and Samonov (along with hundreds of other researchers) have come to conclude that well-devised trend-following strategies can increase returns and decrease equity drawdowns, as I have shown in this paper.
Here’s wishing you great success in the markets!
People are good at a lot of things, but on average and over time,
investing money isn’t one of them.
6. The average investor is brilliant at mistiming the markets.
If you are looking for an investment strategy that can generate strong returns with lower portfolio volatility, it’s a loser’s game to pretend to be smarter than the market.
Instead, use a strategy that always puts you in sync with the market’s trends – and ignore the ego’s need to show off its own brilliance.
1. Investing is about risk and reward trade-offs – you simply can’t have it all.
To figure out which investment strategies are right for you, you need to look at more than the long-term average annual rate of returns. You also need to look at the volatility and equity drawdowns of those strategies to see if they are something you can realistically live with.
The buy-and-hold strategy, for example, may be highly profitable in the long-run – and this is especially true if you are primarily invested in U.S. stocks – but in your quest for high returns, how large a drawdown you can stomach is something that all investors need to think over.
Well-designed trend-following strategies can not only produce higher long-term returns than buy-and-hold strategies, but they can deliver those returns in a way that doesn’t expose you to equally higher levels of risk – which means less volatility and lower drawdown numbers.
This is why simply buying and sitting on U.S. stocks (or ETFs) for decades does not make much sense to me.
If you can only live with the lowest levels of risk and volatility, you should consider using a trend-following strategy to invest in less volatile assets – like bonds – but you’d have to be willing to settle for long-term returns that are roughly half those of U.S. stocks.
2. “What” is happening in the markets is all that matters –
not “why” it’s happening.
One of the reasons that trend-following is my preferred investment strategy is because price signals are the language of all asset markets. Based on my 50 years of experience during both bull and bear markets, I have learned that when the markets talk, it’s wise to listen.
You never really know the real reason for the movements in the market. There are 2-3 legitimate sounding reasons that are thrown out there every day explaining why the market moved one way or the other – and these “reasons” seem to change constantly.
One day those 2-3 things “matter” to investors but the next day it’s a completely different set of things that matter – and no one has any recollection of what happened the day before.
In Timing the Real Estate Market, I write that “the best and most reliable investment information does not come from the experts or newspaper headlines. And salesmen are the worst place to get unbiased information! Instead the best information comes from the market itself – and the market speaks to you in a language that reveals its future intentions.”
My friend Richard Russell (Dow Theory Letters) taught me a long time ago that “the market is its own best predictor” – and we trend-followers live by that sound advice.
Here is a summary of why I feel well-designed trend-following strategies are
superior to buy-and-hold investing.
There are clearly times when it is a good idea to be invested in any given asset market by buying and holding for a lengthy period of time. But you also need a strategy for exiting those markets when the big declines come along – because they will come along.
Let’s compare the two trend-following investment strategies (#2 and #3) against the buy-and-hold strategy (#1).
The 35-year test period for Strategy #2 added more than 2% return per year, lowered volatility by 55% (from 15.5% to 6.9%), and decreased the maximum equity drawdown by 79% (from -44.7% to -9.5%).
Strategy #3 increased returns by more than 7% per year, decreased volatility by 20% (from 15.5% to 12.4%), and lowered the maximum equity drawdown by 38% (from -44.7% to -27.5%).
If you like real estate, here's another profitable trend following strategy.
Simple and Effective
Of course there are no guarantees in this business – regardless of what strategy you use. There will be years that are bad for trend-followers and there will be years that are very good. Over time, however, it is likely that both
Strategy #2 and Strategy #3 will outperform the traditional buy-and-hold strategy and produce strong excess return – but always know that we are dealing in probabilities and not mathematical certainties.
Being in sync with trends is one of the most critical aspects of investing – and that’s why I wrote the book Timing the Real Estate Market in 2002. It tells readers what key leading indicators are important to focus on, as well as how to use a clearly defined trend-following methodology that has historically given us advance warning to the impending peaks and valleys of real estate cycles.
How important is real estate timing?
Based upon my 45+ years of experience in the real estate business, here is how I would summarize my observations:
Consistently making money in the markets is every investor’s goal, and it’s my view that whether you are a real estate investor … or whether you invest in stocks, bonds, commodities or any other asset class … that trend following – as opposed to buy-and-hold investing – should play a prominent role in the strategies you use to increase your gains and lower risk.
This belief, however, is in the minority.
According to the vast majority of financial advisors and banks, the safest and most prudent way to invest is to buy and hold a combination of stock and bond mutual funds (or ETFs) for the long run.
This advice may seem very reasonable considering that the long-term returns of U.S. stocks have been superior to other asset classes – but experienced investors know that it can be a scary ride along the way.
Trend- following helps you ignore the short-term noise in the markets.
The case for Trend- Following Strategies