Trend following

“The crowd may be stupid, but they are stronger than you. Crowds have the power to create trends. Never buck a trend. If a trend is up, you should only buy or stand aside. Never sell short because “prices are too high” — never argue with the crowd. You do not have to run with the crowd — but you should never run against it.

Dr. Alexander Elder

Mark Boucher on using RS

One of the most important lessons that a successful stock investor needs to learn is that there are times when the market presents plentiful low-risk opportunities and there are times when making money in the markets is quite difficult and far less certain. Adjusting one’s strategy for different market environments is key. You can trade aggressively in a terrific market environment and make triple digit annual gains with easy. But trading just as aggressively in a very difficult market environment could result in huge drowdown of capital. Remember that a 50% drowdown erases 100% gain just to get back.

Over the years one of the most common stories I have seen is for smart investor to begin investing very  aggressively during stock market run-up, when the opportunities are plentiful. The smart investor will have a strategy that exploits the good environment quite well – an he’ll typically make huge gains of about 500%-1000% of his money in one to three-year period. But when the market environment changes, this investor refuses to change with it and in the following one to two-year period, the investor losses most or all of his trading capital. Foxhound Funds levereged 300% gain in 1999, but a total of 100% loss of everything by April 2000.

Clearly learning to understand when one can be aggressive, and to understand when to be defensive is important to investors, desiring to maximize gains wit minimum risk.

Marketsci on what overnight gaps tell us about the stock market

  1. The idea that the overnight market (close to open) doesn’t influence the daytime market (open to close) is usually correct, but NOT when the overnight market is moving violently like it has recently.
  2. Large gaps down exhibit a relatively strong negative correlation to subsequent daytime changes indicating a tendency to reverse some of the overnight gap in the daytime. I haven’t shown it in these statistics, but the larger the gap down, the higher the average return and the more negative the correlation (but also the higher the volatility) of the daytime reversal.
  3. Large gaps up do not exhibit a consistent influence in all market conditions. Also not reflected in these statistics is that as the size of the gap up increases, the correlation to the daytime market becomes more and more asymmetrical based on the broader trend. In up trending markets, these very large gaps up exhibit strong follow-through (positive correlation), but in down trending markets, very strong reversal (negative correlation).’