I am trialling a new trend following stock trading strategy. This strategy looks for stocks breaking out to new 52 week highs. The stock must also have decent sized volume, a PEG less than 1 and an RSI score less than 70. Trades are exited on a 20 week low. So far, results look promising but too early to say whether it will work longer term. I am paper trading this before taking it live.

Here are this week’s trend following stock picks. Both are in the auto parts industry suggesting that this is a good sector to be involved in as a whole. Normally I wouldn’t buy more than one stock in the same sector. Out of these two I’d go for MGA.

Magna International Inc ($MGA)

Magna International is an auto parts wholesaler based out of Canada with 128,000 employees in 29 countries. The stock has broken to a new 52 week high but the financials are in good condition. PEG is 0.99 and price to sales is 0.67. EPS has grown over 100% over the past 5 years and current ratio is 1.30. The stock also has 5% insider ownership.

trend following stock picks mga chart

Lear Corp ($LEA)

Lear was founded in Detroit, Michigan in 1917 and  is a leading manufacturer of assemblies for the automotive and aircraft industries. PEG is 0.94 and forward PE is 10.30. EPS is expected to grow at over 18% over the next 5 years.

trend following stock picks lea chart

 



People often want to know whether forex trading is profitable. They see a strategy online promising 1000% returns and millions of dollars in profits and wonder whether they too can become successful forex traders.

On the flip side, though, they will also have heard the stories of those traders who have lost money and in the back of their minds they will wonder if forex trading is no different to gambling.

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In this article I look at a simple 50 day moving average strategy and use the simulator from Amibroker to test the strategy on the stock market.

When it comes to technical analysis and trend following there is no shortage of naysayers.

Academics like to say that markets are perfectly efficient and that short term moves are nothing more than random. But if that is the case, how can so many stocks be riding high one minute then cut down the next?

Others believe that macro-economics drive prices and dismiss trend following out of hand. The fact is, however, trend following strategies work and they have been working for some time.

One very basic but popular trend following strategy is based on the 50 day moving average. In this article I look at whether this simple strategy can work in todays markets.

50 Day Moving Average Strategy

To test the 50 day moving average strategy I opened up the Amibroker trading platform and wrote some basic code. In this first test, the system buys a stock when the 50 day moving average crosses over the 200 day moving average. It sells when the 50 day moving average crosses back under.

(This a portfolio system that holds a maximum of 10 stocks at any one time. Risk is divided into 10 equal positions and commissions are set at $12 per trade. This was tested on stocks in the S&P 1500 US stock universe between August 2000 and August 2010. Trades are entered on the next day open.)

Test 1:

Buy = 50 day MA (close price) crosses over 200 day MA.
Sell = 50 day MA (close price) crosses under 200 day MA.

CAR: 16.94% Max Drawdown: -54%

50 day moving average strategy

As you can see, over stocks in the S&P 1500 between 2000 and 2010, this simple 50 day moving average strategy actually did very well.

Now let’s see how it does when the MA is substituted for an EMA (exponential moving average)

Test 2:

Buy = 50 day EMA crosses over 200 day EMA.
Sell = 50 day EMA crosses under 200 day EMA.

CAR: 3.58% Max Drawdown: -69%

50 day moving average strategy test 2

Surprisingly, the EMA strategy does very poorly compared to the simple MA and delivers a much larger drawdown.

Next, let’s see how the same 2 strategies work on weekly data instead of daily data:

Test 3:

Buy = 50 week MA crosses over 200 week MA.
Sell = 50 week MA crosses under 200 week MA.

CAR: 11.63% Max Drawdown: -67%

Test 4:

Buy = 50 week EMA crosses over 200 week EMA.
Sell = 50 week EMA crosses under 200 week EMA.

CAR: 8.50% Max Drawdown: -63%

From these very rough and simple tests we can say that Test 1 looks the most promising. It produces the highest annual return (CAR) and the smallest drawdown.

Test 5 (out of sample):

Now it is important to see how the test does on out of sample data, to see whether this 50 day moving average strategy could actually work going foward. I therefore moved the test forward and ran the system between 1/1/2010 to 1/1/2014. The results are as shown below:

CAR: 11.42% Max Drawdown: -26%

50 day moving average strategy test 3

These out of sample results look promising. The annual return is high and drawdown low. They are not as good as the insample (Test 1) and that is expected.

Test 6:

For this final test I wanted to see whether buying a stock when it moves above its 50 day moving average could be a worthwhile strategy. This is a strategy I’ve read about in the past. It buys when the open price moves above the 50 week MA and sells when the open price moves below the 50 week MA.

Buy = Open price crosses over 50 week MA
Sell = Open price crosses under 50 week MA

50 day moving average strategy test 6

As you can see from the chart, this system doesn’t work well at all. It enters a lot of trades and suffers from too many whipsaws. This strategy did just as poorly when using EMA instead of MA and on daily data instead of weekly data.

Conclusion

It is impossible to say from these tests whether any of this strategies will work in the future, (though we can pretty much eliminate test 6 since it produces too many trades to be profitable). More testing needs to be done to verify these tests on different data sets and it is important to also include delisted stocks.

However, the simple 50 day moving average strategy shows enough promise here for further analysis. The adding of rules and filters may be able to turn this into a worthwhile trend following strategy.


trend following stocks gifTrend following is an investment strategy based on the technical analysis of market prices, rather than on the fundamental strengths of the companies. Wikipedia

My own view is that trend following is not necessarily based on technical analysis, which can sometimes have a bad name. I believe trend following is more about the philosophy that long term trends are a natural phenomenon of market cycles. It works because it is able to capture the ‘long tail’ of market returns. In that regard, it is a unique and effective strategy. But like any good strategy, the rules need to be followed in order to capture the returns.

If you’re still not convinced have a look through Google Scholar and see what you can find. This journal for example looks into the performance of trend following for hedge funds, while this classic white paper ‘strongly suggests‘ that trend following on stocks has a ‘positive mathematical expectancy‘.

As well, the quantitative encyclopedia, Quantpedia lists a number of attractive trend following strategies.

For what it’s worth, I have done hundreds of back-tests myself and have found that trend following works very well on stocks. (I will be posting some of these up at a later date). So here are 29 rules, for trend following stocks:

29 Rules for trend following stocks

1. Price is everything.

2. Ignore the news.

3. Buy a stock when it breaks out of a range.

4. Sell a stock when the trend changes.

5. Buy a stock when it makes a new high.

6. Short a stock when it makes a new low.

7. It’s harder to short stocks than it is to buy stocks.

8. Some stocks trend more than others.

9. Diversify when you can.

10. Ignore the whipsaws.

11. Don’t chase the market.

12. Let your winners run.

13. Cut your losses short.

14. A stock can always go higher and always go lower.

15. Don’t get out before the trend changes direction – look to catch the middle.

16. Trend followers have more losers than winners.

17. 40% is a good percentage of winners for trend following stocks.

18. Put your stops far enough away to allow the trend to develop.

19. Don’t fall in love with a stock.

20. Don’t pick bottoms.

21. Don’t pick tops.

22. Don’t try and predict the market – go with the flow.

23. Follow your signals.

24. Trade small enough you won’t go broke and large enough to make it worthwhile.

25. Compound your returns.

26. Trend following stocks works best with a system.

27. Back-test your system.

28. Don’t forget delisted stocks.

29. Stick to the system.


In my new book, I detail 20 trading systems tested on stocks from the S&P 500, 14 of which are trend following. Be sure to check it out if you are interested in trend following strategies for stocks.

link for my book