Trend Following Forex Charts

I have been bullish on stocks for all of the year 2013, but one asset class that I have not been bullish on is commodities and commodity currencies.

The reason I am not bullish is due to one factor:  the price.   As this daily chart of the Australian Dollar shows, the price, at this moment, is currently going down:

More specifically, the long term trend, as well as the short term trend are down.  Furthermore, the Aussie has recently been hitting new 52 week lows.   That is bearish.

Moving on, the next chart is a monthly chart of the Australian Dollar:

Before entering a trade, I like to have confirmation from multiple time frames.    The above chart shows the price breaking down from a multi-year consolidation area.

Because the Australian Dollar and Canadian Dollar tend to be correlated, one would expect the Canadian Dollar to also appear bearish and that is, in fact, the case.

Below is a monthly chart of the Canadian Dollar:

Four Potentially Explosive Stocks: $ALQAD, $FCEL, $MILL, $PLUG

Here are 4 stocks, all of which I currently own, that look very bullish to me:

Here are some commonalities amongst these 4 positions: 

  • Each position starts off with a 2 ATR stop  (If you have no clue what this means, watch this
  • If this stop loss is hit, I lose 1% of my entire account equity
  • All of the stocks are in long term uptrends.   Never fight the long-term trend.
  • All of the stocks are in short term uptrends.   
  • All of the stocks are at or near 52 week or all time highs
  • They are all rising on hugely expanding volume

Seasonal Stock Market Trends

One of the things that attracted me to the trend following trading world the most was the evidence. Thanks to Michael Covel's original work, I was able to see, going back decades, month by month performance data for a wide range of traders across the world.

You simply cannot find this kind of data for other trading styles such as fibonacci, Gann, or Elliott Wave.  Sure, one prominent Elliott Wave theorist may have called the 1987 market crash, but how has his performance been, month by month, since then?    I have been looking for month by month data for these type of traders and have found nothing.  And I've been intensely studying the stock market for 8 years now. 

Anyway, while there is a plethora of data supporting trend following trading,  there is another trading style that also has significant data to support it:  seasonality. 

I am attracted to hard data, not myths, so when I read the book Seasonal Stock Market Trends, by author Jay Kaeppel,  I was impressed.    There is a lot of raw data in this book, going back more than 100 years, some of which I thought was very statistically significant. 

There are a lot of findings presented in the book above, but for this post, I will focus on just one: the month of December. 

The data suggest that the month of December, or the period between the American Thanksgiving and New Year's Day, is the sweet spot, if you will, for the stock market, producing more gains during this time than any other month. 

To help me demonstrate this point visually, has just come out with a new seasonality charting tool.   The tool is free to use by anyone and can be found here.

Using this tool, I created the following chart, which shows the percentage of the time the Russell 2000 increased during the month of December between 1994 and the present: 

Significantly, the Russell 2000 has increased 90% of the time during the month of December going back 20 years.  Why does this powerful pattern tend to emerge year after year?  I do not know - I am extremely reluctant to link cause and effect in the stock market. 

The next chart shows that the Russell 2000 never closed down during the month of December between the years 1991 and the year 2000:

This season pattern does not appear to be limited to US stocks either.   The next chart shows a similar pattern for the UK's stock market: 

Finally, individual stocks appear to succumb to this inexplicable seasonal force as well, with shares of Google rising 90% of the time during the month of December for the last 10 years.  

As a trend following trader, do I trade off seasonal patterns?  No, I don't.    Can seasonal tendencies be combined with trend following principles in a systematic and profitable way?   Probably yes. 

  • "You can be very promiscuous in your research, but not in your trading."

Stocks are Undervalued, Oversold and in the Process of Bottoming

I hear a lot lately that stocks are in a bubble, over-extended, over-valued and about to top out.   Although anything is possible, and the top pickers will eventually be correct one of these days, I do not come to this conclusion.

In this post, I would like to share two very long-term charts that I hope will show US stocks in a different light.

The first chart goes back to year 1982 and shows the relationship between stocks and bonds during this time:

The chart above shows that US stocks were in a true bull market from 1982 to the year 2000.   Since that time however, stocks have been in a corrective consolidation period for the past 12 years.  It is only now, at long last, that stocks appear to breaking out of this bullish channel.

From this long-term perspective, stocks do not appear to be in a bubble to me.   If a bubble does exist, it is more likely to be in the bond market - not the stock market.

Moving on, the next chart shows the long term relationship between stocks and gold:

Similarly, we see that stocks were in a true bull market from 1982 to the year 2000.    Interestingly, though, through the lens of real money, stocks truly only bottomed in the year 2012 and have only recently broken out.

From this perspective, stocks actually appear undervalued and oversold to me.   Paradoxically, it is gold, the metal that everyone seems to think is nearing a bottom, that is over-valued.

Five ETFs that I am Selling Short: TZA, TLT, FXP, UNG, FXY

I like to short sell ultra ETFs that are in major downtrends.  Since I have discussed my reasons for doing so before, I will not go through the rationale again here.   However, here are 5 new ETFs that I currently have positions in:

Trading in the Direction of the Long Term Trend: Stocks, Yen, Silver, Bonds

As a trend following trader, I always trade in the direction of the long term trend.    Doing so keeps me on the right side of the market most of the time and helps give me an edge.

I define the long term trend by using a 100 and 150 exponential moving average crossover.  If the 100EMA is above the 150EMA, the trend is up.    If the 100EMA is below the 150EMA, the trend is down.   Following such a rule is simple, objective, unambiguous and emotionless.

Here are 4 different markets for which I have charted the long term trend.  While these charts are not meant to be predictive (they are reactive), it is worth noting that a trend in motion does tend to stay in motion.

1) US Stocks: 

The chart above displays the long term trend for the ETF SPY going back to 1996.   As I have mentioned numerous times throughout this blog, the trend is up, which is why I have continuously been buying stocks.

2) The Japanese Yen: 

Another market that I am keeping an eye on is the Yen.   From both a purely trend following perspective and also from a classical technical analysis perspective, the Yen appears bearish to me.

3) US Government Bonds

The long term trend for bonds turned down last summer and remains in a downtrend today.    As fellow chartist Olivier Tischendorf astutely points out, this could be the beginning of a mega-trend.

4) Silver

The price of silver has surprised many by falling 60% from its high, but had one followed the pure price action of the metal, one would have avoided a great deal of financial pain. And just because silver has already fallen 60% does not meant it cannot fall another 60% - a trend in motion tends to stay in motion.

Five Reasons Why I Would Never Buy Twitter Today

1) The stock will not have an Average True Range (ATR).    I use the stock's volatility to determine how many shares to trade, so without this key missing ingredient, I do not know how much to buy.

2) I would not know where to place my stops.   I place a stop 2X the ATR below my entry price, so without the ATR I cannot optimally place my stop loss.

It is true that many traders use percentages to place their stop losses.   This is, to be fair, much better than nothing, but it is sub-optimal.   For example, a 7% stop loss for a blue chip stock like IBM is totally different from a 7% stop loss on an ultra ETF like NUGT.  Thinking in terms of volatility makes everything an apples to apples comparison.

3) There is no short term trend.   I need the 20 day moving average to be above the 50 day moving average, as a minimum, for me to consider a stock.

4) There is no long term trend.  When I buy a stock, the long term trend should be up.

5) I wouldn't know where to take profits.  I generally ride a stock higher as long as it stays above its 20 day moving average, however the stock is too new to have formed that.

The bottom line is that it is impossible to technically analyze or trend follow a stock like Twitter.  When I buy a stock, I need to have an edge, but with a stock like this, it's really just pure gambling.

Larry Hite on Risk Management for Trend Following Traders

I have mentioned before that the world of trading is filled with paradoxes.   Another paradox in the trading world is that the subject that will determine at least 90% of your results is hardly ever mentioned.    That subject is risk management.

The greatest piece of advice I can give to new traders is that they should only risk 1% of their account equity on any given trade.   This means, for example, if you start off with $10,000, place your first trade, then get stopped out, your account equity should now be $9,900.

By risking only 1%, your account is able to survive many losing trades in a row.   But how many losing trades in a row should you prepare for?

Let us say that 50% of your trades are winners.   The table below illustrates how many losing trades in a row you can expect, mathematically:

As the table above shows, over the course of the next, say, 100 trades, you can expect to run into 7 consecutive losing trades in a row.

The next table shows the resultant drawdown you can expect from those losing 7 trades in a row based on different bet sizes:

The table above shows that, for example, if you bet 5% on each trade, then 7 losing trades in a row will drawdown your account equity to $6,983.   And this is the scenario based on just your next 100 trades. If you trade over the course of years and decades, you could easily run into a patch of 14 or 15 losing trades in a row.

This is why, in my studies, I have come to the realization that all old traders bet small.  The reason is that had they bet big over the course of 15, 20, or 25 years, they would have gone extinct and I would not have been studying them in the first place.

Bottom Line:  If you don't understand bet sizing and risk management you will, mathematically, go bankrupt eventually.

  • Two basic rules:  1) If you don't bet, you can't win.   2) If you lose all your chips, you can't bet.
            -Larry Hite

Scanning Stocks for Nicolas Darvas Style Breakouts

I think that my strategy of buying stocks making new 52 week highs or all time highs works for any market, but what makes the stock market different from other markets is that, unlike the Forex or commodity markets, there are thousands of stocks to choose from.

With so many stocks to choose from, I rely heavily on scans to narrow down a universe of about 10,000 stocks to a more manageable number.

I use to perform my scans and there are five scans that I go through, which I will summarize below:

1) Breaking out of consolidations to new 52 week highs: 

The chart above shows an "ideal" example of what I am looking for.   The scan looks for stocks that have been consolidating for the past 4 weeks or longer and are now trading at a new 52 week high.

2) Above average weekly price advances: 

Because I believe that strength tends to beget more strength, I scan for charts that display bullish, tall, weekly candles.

3)  Volume scan #1:

When I buy a stock, I have little or no knowledge of what product or service the company provides.   However, if you follow volume patterns, you can end up trading with the smart money anyway.

4)   Volume scan #2: 

This scan looks for stocks whose volume is significantly higher this week than last week.

5)   Volatility Contraction scan: 

This scan looks for a major decline in a stock's volatility as measured by bollinger band width.    Often, volatility for a stock will decline before a major explosive move.

If you are interested in creating your own scan with, but are uncertain as to how to code it up, please contact me.

German, Japanese, Canadian Stocks at New Bull Market Highs

A simple rule of thumb that I have developed through analyzing charts each and every day for 8 years is that when a market makes new all time highs, that is bullish.

I am, therefore, bullish on German stocks, since they too have broken out to new all time highs:

The chart above is a long term monthly chart of the German DAX.    Notice, as well, that German stocks are barely trading higher than they were in the year 2000.

I've been reading a lot lately that stocks are super over-extended and in a bubble.   Based on the fact that most stocks, even US stocks, have made almost no progress in the past 13 years, I do not share this opinion.

If you think making no progress in 13 years is bad, then consider Japanese stocks, which are trading at the same level they were in 1986:

Zooming in, here is a weekly chart of the Japanese iShares, EWJ:

The weekly chart above shows what, to me, is a bullish flag on the verge of breaking out. 

Finally, even Canadian stocks are making new highs: 

Bottom line:  globally, stocks are currently rising and making new all time highs, or at least 52 week highs.   Why fight that trend?

Six Reasons why Trend Followers Know the S&P 500 is in a Secular Bull Market

1) The S&P 500 keeps making new all time record highs.   This started happening again 14 months ago, which I pointed out here.  Since that time, the market has continued to print hundreds of new all time highs and is, at this very moment, at yet another new all time high.

If any market is printing new record all time highs, that is always a sign that a major bull market is underway.

2) The Dow Jones is breaking out of a 12 year consolidation period, which I pointed out using this 112 year Dow Jones chart .

Generally, if a market consolidates for a decade or two then breaks out, that is a positive development.

3) Foreign markets, for example the German DAX and the EAFA index are hitting new highs.  If foreign markets are surging ahead, that is another sign that stocks are in a secular bull market.

4) The perma-bears have been spectacularly wrong.   Since the year 2008,  I have heard those who have said that the US Dollar would implode, silver would go to $100 an ounce, the worst place to invest your money would be in American stocks, and the best place to take refuge during the imminent and inevitable hyper inflationary collapse would be in gold stocks.

I admit that this all seemed plausible at the time, but the pure price action of the market told a different story.

First of all, for the last two years, American stocks, rather than being the worst place to invest your money, have been the best place and have done much than gold has.   In fact, gold entered into a bear market 16 months ago and has not looked back.   Finally, instead of being the best place to invest your money, gold stocks have been literally the worst sector for several years now.

If money is fleeing these safe haven assets, as was the case during the beginning of the previous secular bull market in 1981, then that is a positive development for stocks.

5) Leading stocks, such as Google, have led the Nasdaq to new 12 year highs.   This is another sign that we are in a major secular bull market.

6) The VIX Index, which measures the level of fear in the market,  has been in a major downtrend, despite what you may have been led to believe by watching the news.   If the VIX keeps hitting new lows, that's a sign that we are in a major bull market.

Thoughts on Nick Radge, Michael Covel and The Fountainhead

Last week, I talked about how trend following traders have difficulty appealing to the general public due to the volatility they experience.  

Because novice traders prefer a smooth, steady and predictable equity curve, they erroneously conclude that trend following is too risky, even though in the long run, the opposite is true. 

But couldn't trend followers change their strategy in order to appeal to the masses;  to create something more middle of the road that would suit everybody?  

This thought, along with a superb YouTube video by Nick Radge as well as Michael Covel's recent podcast, inspired me to create my own YouTube video.   Enjoy:

Why do Trend Following Traders Win the Money that Novice Traders Lose?

I find that the world of trading is filled with paradoxes.   In this post, I will discuss one of these paradoxes: 

  • Traders who have a high win rate appear safe, yet actually tend to be fragile and risky.   
  • Traders who have a low win rate appear risky, yet actually tend to be robust and safe. 

We are taught in school that good grades are desirable and those with higher marks will end up achieving greater success in life.  Paradoxically, in the world of trading, it's just the opposite:  traders who have very high win rates are prone to failure.  

For example, I have identified one money manager who has a win rate of 98.6%.    This means that out of 100 trades, about 98 or 99 will be closed out at a profit.   To the novice trader, he sounds like a genius, that he must have found "the secret" of trading, or "the holy grail".   

In order to achieve this, the money manager does not sell a position for a loss, but instead doubles down.  After averaging down, if the position is still in the red, he will average down again.   This goes on indefinitely, until the position can eventually be closed out at a profit.  

The problem lies in the 1% of the time where you keep averaging down, but the position does not revert to the mean and keeps on trending.  You keep averaging down, over and over, until you reach the point where you run out of money and you find yourself, well, completely bankrupt. 

Here is a picture of this money manager's equity curve: 

The equity curve initially appears safe and steady, but contains an extreme amount of risk lurking under the surface.   

The unfortunate clients of this money manager are what Nassim Nicholas Taleb would refer to as turkeys, as the following quote from his book, The Black Swan, illustrates: 

A turkey is fed for a thousand days by a butcher; every day confirms to its staff of analysts that butchers love turkeys “with increased statistical confidence.” The butcher will keep feeding the turkey until a few days before thanksgiving. Then comes that day when it is really not a very good idea to be a turkey. So, with the butcher surprising it, the turkey will have a revision of belief—right when its confidence in the statement that the butcher loves turkeys is maximal … the key here is such a surprise will be a Black Swan event; but just for the turkey, not for the butcher.

As for me, I do not have a 98.6% win rate.   I have a 53% win rate, and my equity curve does not look safe and steady, but rocky and lumpy.   To a novice trader, it does not look very attractive at all. 

I'll leave you with three quotes:

  • The desire to maximize the number of winning trades (or minimize the number of losing trades) works against the trader. The success rate of trades is the least important performance statistic and may even be inversely related to performance.

-William Eckhardt

  • The equation is simple - most important is how much you win when you win, and how much you lose when you lose. Forget right or wrong.

-Nick Radge

-Michael Covel

Does Trend Following Trading Work for the Stock Market?

In this post, I will explain an incredibly simple, yet effective, trend following strategy that has been backtested all the way back to 1963.   The rules of the system are as follows:

  • If the Nasdaq is trading above its 100 day simple moving average, you buy it
  • If the Nasdaq is trading below its 100 day simple moving average, you sell it and go in cash

Here is an example of how this strategy would have worked for this year:

The Nasdaq was trading above its 100 day moving average for all of 2013, so you'd have bought and held.  If the market is going straight up, I have nothing against buying and holding. 

Where this strategy shines, however, is in bear markets.   The chart below shows the Nasdaq during the year 2002:

By selling and going into cash for most of 2002, the strategy does not make any money, but it does preserve capital, which is key. 

Here is a table showing a year by year performance breakdown of the strategy versus simply buying and holding:  (Source)

Over nearly the past 50 years, following this simple, passive, objective rule would have increased your rate of return by approximately 65%

In a sense, I use this strategy in all of my stock picks in that every one is always above its 100 day moving average.  In fact, by buying stocks making new all time highs,  you're pretty much always going to be doing this by default.