Chart of the Day – The Trend Followers’ Main Metric

by Enis June 7, 2012 8:03 am • Commentary

The trend is your friend.  You’ve probably heard it countless times, and I generally roll my eyes when I hear it myself.  If only it were so simple.  Where does the trend end and a new one begin?  Which trends should you trade?  What if the market keeps mean reverting?  The questions are endless.

However, over the years, I have found some use to this adage in my own trading.  When the trend is obvious, it generally is much harder (both on your mental capital and your actual capital) to try to push against it.  It can certainly be profitable, but quite taxing as well.

So how do you measure the trend?  Through my own reading and experience, I’ve come to regard the 20-day moving average (basically one calendar month) as a good indication of the direction of the short-term trend, probably because so many traders watch the same level to add or reduce to their positions.

The major asset classes have all been in well-defined trends above or below their 20-day moving average for the past month, and are testing or breaking those levels this morning.

Starting with SPX futures, with the purple line denoting the 20 day moving average:

The market is breaking out this morning, with the Chinese rate cut announcement at 7am gave the final push that hit a lot of buy stops above the 20 day ma.  In my view, this muddies the near-term outlook, and will keep me from initiating many bearish positions until the trend re-asserts itself.  Why not initiate some bullish positions?  The long-term trend remains lower, particularly supported by other global markets and asset classes, so I prefer to trade in the direction of those signals.

Treasury bonds (as measured by TLT) are actually still above their 20 day ma, even with the severe selloff we’ve seen this week:

It’s worth noting that bonds are maintaining their uptrend for now, but are not far from a break of the 20 day.

Finally, the U.S. dollar as measured by UUP is still above its 20 day ma, though also nearing a test of it:

However, some of the emerging market currencies I talked about last month have broken their downtrends vs. the U.S. dollar, which is also a bullish sign for near-term risk.

Put it all together, and I’m back to neutral from a relatively bearish stance over the last few weeks.  I do have SLV puts in July, my least favorite position, and one I still plan to adjust at some point.  The AZO flier is July as well, but that concerns me less for now given the risk/reward.  I am most comfortable with my BMO puts since they are September expiry, and BMO is my highest conviction position.  Finally, I am contemplating taking off my CAT put spread in August, depending on how it acts today.