A simple way that you can become your own investment adviser using the trend following plan developed by Dick Fabian.
Signal Methods
You may not like the simple trend following method I have been talking about. There are many ways to generate your Buy and Sell signals. Listed here are just a few variations.
As described earlier, the trend following method I follow uses a moving average to generate BUY and SELL signals.
The primary signals are generated by the price movement above and below the moving average. As the price moves above the moving average that is a BUY signal. As the price moves below, that is a SELL signal. Although the Fabian system was developed using the 39WMA for signals, today the 200 day moving average or the 40 week moving average can be used.
The one big drawback to trend following is what's called the "whipsaw". That is where you get one signal, a move across the moving average, followed shortly by an opposite signal, a move back across the moving average. Whipsaw trades almost always result in a small loss. A trend follower was once asked "how do I avoid whipsaws?", his answer, "don't trade". Whipsaws can and do happen, you just need to learn to deal with them. One thing to remember is that it's only a whipsaw later. Today it's a signal. Think about that. The discipline is to take the signal. Only later will you find out if it was a whipsaw. This is the price you pay to be a trend follower.
Whipsaw trades are one of the reasons I use the 40 week moving average. It helps smooth out some, not all, of the market movement.
This is the Wilshire 5000 with the 40WMA.
Another way to try and reduce, not eliminate, whipsaw trades is to slightly modify your trading rules. A simple alteration to your signal rules, that hopefully will reduce whipsaws, would be to use an envelope around your moving average. This will give you a little cushion for your signals and should help reduce whipsaws. The change to your BUY or SELL signal becomes the breakout to the top of the envelope for a BUY and a breakout to the bottom of the envelope for a SELL. This type of deviation from the exact moving average signal is sometimes referred to as a penetration. You wait until the price line penetrates the moving average by X%. You can set your envelope to whatever range you want. Remember, your BUY signal is a breakout through the top of the envelope and your SELL is a breakout through the bottom of the envelope. The moving average itself is no longer used. The cushion then becomes the range between the top of the envelope and the bottom of the envelope.
Here is the Wilshire 5000 with the 40WMA and a 1% envelope around the 40WMA.
Here is the Wilshire 5000 with the 40WMA and a 2% envelope around the 40WMA.
A method that AL Thomas talks about uses is the 200DMA or 40WMA. Using this method, changes are not made until the slope (direction) of the MA changes. For example, if the price line breaks below the MA (200 DMA or 40WMA) there is no SELL signal until the slope of the MA (200DMA or 40WMA) reverses from ascending to descending. That's to say you take no action until the moving average starts to go down. The same would be true on the BUY signal. No change is made until the slope of the MA changes from descending to ascending.
Another method used is what is called the Moving Average Crossover. That is where you use two moving averages and the signal is generated when one crosses the other. Typically, you would you one shorter and one longer moving average. Many crossover systems I have looked at use a 3:1 ratio.
The Investopedia.com definition for simple moving average actually shows an example of the 15 day simple moving average giving a crossover signal with the 50 day moving average. You can play around with them to see which one you might like.
For example:
10DMA & 30DMA
20DMA & 60DMA
30DMA & 90DMA
40DMA & 120DMA
50DMA & 150MA
If you go to StockCharts.com you can try some out.
Yet another method, that some use, is to look at a daily view of the Wilshire 5000 with a 200 day moving average. You then would look at a weekly view of the Wilshire 5000 with 40 week moving average. Your confirmation is when both views are above, or below, their moving average.
I have found many trend following type investor sites that offer free information. You will find some of them listed on the People Page. This list is in no way complete. I would suggest you check out their site and educate yourself as to what is out there. Many offer free newsletters and alerts sent to your email inbox. Check them out.
A subscriber to my Momentum Monitor has done extensive research on trend investing as he calls it. Here is part of our email exchange where he talks about some of his findings.
4/10/09
Chuck,
I am excited at getting to read your stuff, and look forward to it. I have been a trend investor ever since I heard Dick Fabian lecture on his methods in the early 1980's, and I subscribed to his original letter, "The Telephone Switch Newsletter."
I have studied the markets with my semi-log charts from 1927 through 2008 the last few months, analyzing when and why moving averages worked best (in secular bears--as in 2000 through 2008---, NOT in secular bulls--as in 1980 through 1999--).........and comparing all the various cross-over moving average systems to the 200 day/20 day system (which is clearly best by my testing), vs. just using a straight 200 day average...........and also looking at when and if playing the short side added value as well.
When I get more time for analysis, I want to run some comparisons on a Bollinger band system, with a 50-day moving average confirmation, suggested to me by a smart friend who is a retired broker.
By my methods, as of tonight, I am not a buyer;although, the emerging markets and the QQQQ seem to be closing in on a buy point.
thanks,
Will
4/12/09
Chuck,
I have read the original Fabian self-published manual, and may have it "hidden" in all my books stuck here and there;however, I just re-read his 2001 book published by McGraw-Hill in which he included his "ADVANCED PLAN." I think the advanced plan is where he begins to go wrong looking at general market indicators all over the world, using enhanced funds, but he never played the "dark side" as best I can read. I think that Dick was beginning to realize that over some market times, his "great idea" of momentum investing simply does not work..........read on:
Next, I found a Mark Hulbert article written about 2002, that analyzed the Dick Fabian system, and the conclusion in that article was that the system use to work, but apparently did not work anymore. Actually, this article and Fabian's tampering with his original system is what stimulated me to look at how the Fabian system actually did work in the real world, throughout history, just trading the standard indexes.....read on:
I looked at the 200/20 day moving average.........i.e. using a 20 day SMA to soothe out the plot of the index I was looking at, and issuing a buy signal when that 20 day crossed the 200 day moving average. Using a 20/200 eliminated a lot of the whip-sawing that occurs when using as a buy/sell point just when the underlying index itself crosses. Also, as modern momentum player prefer, I wanted to see both lines in an up-trend AND the underlying index plot above both lines before I bought. Likewise, I looked at trading the dark side using the same rules. I spent several weeks looking at the S&P, and in the old days I substituted the DOW as it goes back to the turn of the century historically, when the S&P was not available. Another nuance is that I used a semi-log plot, which shows rate of change better than a standard plot.
To my total surprise, there were great periods of time when using moving averages did not work, both on the up-side and on the dark side..........and where just buy and hold, was far superior. So I asked myself, why and during what times did momentum investing fail to buy and hold, and I found an answer.
If you look at the US market from 1927 to 2008, year by year, using semi log plots there are two clear-cut times of secular bull markets and three clear-cut secular bear times. Secular bull means that the markets had a strong uptrend bias, and secular bear means that over an extended time, the market was flat.
Secular Bull Markets:
1. 1943--1964
2. 1980-1999
Secular Bear markets:
1. 1929-1942
2. 1965-1979
3. 2000-today
Buy and Hold just beats the pants off of momentum during secular bull markets, but in secular bear markets the opposite is true. This explains why in 2002, Hulbert is writing about the recent failures of the Fabian system, and also why Dick, himself, began revising his original system after 2000.
My conclusion is that you better know the type of market you are in, before you blindly follow any strategy. Also, I do think that we are currently in another Secular Bear, which should continue for a few years yet. First, historically both previous Secular bears were 13 to 14 years long. Secondly, the demographics with the baby boomers beginning to retire, will likely create a headwind for stock prices as this group sells off accumulated assets for retirement living expenses. Thirdly, the Obama economic rescue plan will clearly lead to problems going forward.
As always, government intervention is simply going too an extreme of borrowing, taxing, and massive spending......creating another headwind for business and hence, the markets going forward. If you just look at Great Britian's pattern over the last 50 years of bouncing from the labor government's massive government spending and interventions and financial disaster...............followed by the Margaret Thatcher economic boom era of of privatization, less taxes and less spending................followed now again by the labor government of Gordon Brown's which has Great Britain near bankruptcy with massive tax, spend, and government control policies.................you can see the problem..........and you will note that it is not unlike the USA which bounced from the disasterous fiscal liberalism of Carter to the productive Fiscal conservatism of Reagan........now back to the EXTREME fiscal liberalism of Obama..............
In conclusion, it appears to me that fiscal conservatism is FAR better for my country, but this currently extreme fiscal liberalism while bad for my country, may allow me personally to use my carefully crafted version of the original brilliant Dick Fabian's system, to grow my assets even better than in better times.
Will
p.s. my other extensive studies comparing 30/60, 20/40, and my initial work on using Bolinger bands.....tells me that 200/20 is better most years, but not ALL years. I plan on eventually working out WHY, and also working out which trending measures works best with which indexes........my gut is that more volatile indexes require shorter trending lines.......?.......... I also have on my plate to look at the 65 day SMA used by many, and the 100 day SMA used in Paul Merriman's data on trending (which I need to go back and really study again)..........I am sure that you need to look at decades of data, not short-term data, to be able to have confidence in your systems........and I am also sure that the "devil is in the details" of HOW you define your buy/sell points in trending.........so by the time I DIE, I'll have it all worked out?.........but in the meantime, I'll just follow my "best to date" ideas, I suppose..........I really need a couple of accountant-types to work full-time, running all the variations on all the methods that I think up to test my ideas....................
Wilshire 5000 w 20DEMA & 200DEMA
Wilshire 5000 w 10DSMA & 130DSMA
Wilshire 5000 w 10DEMA & 130DEMA
DSMA=Daily Simple Moving Average
DEMA=Daily Exponential Moving Average