ETF Core Strategies
Aim: To trend-trade general equity ETFs so as to ride rallies and buck busts in the Australian share market.
Market analysis is either ‘fundamental’ or ‘technical’ in nature.
Fundamental analysis endeavors to predict the overall direction of the share market by focusing on the economic outlook, sentiment surveys, individual industry circumstances and political events. Those who monitor ‘fundamentals’ hope to predict the next change in market direction before that change is reflected in share prices.
Technical analysis focuses on analysis of daily share price action. There are essentially two forms of technical analysis however. One form is based on the belief that it is possible to ‘read’ chart formations to predict market direction. Those who use this predictive approach to technical analysis embrace pattern recognition systems based on Fibonacci waves, Dow Theory, Elliott waves, head and shoulder, neckline, double and triple top, wedge, triangle and other formations.
By contrast, MarketTiming adopts a purely quantitative technical approach that tries neither to predict nor to forecast. Our approach is based on reacting to price action. As such, ours is a ‘ trend following‘ approach. We use a variety of technical indicators to gauge a market’s price trend . Trend followers use what we call ‘reactive technical analysis’. Instead of trying to predict the market’s direction, this approach is geared to react to the market’s movements as soon as possible after they occur.
Hence, we seek to respond to the market, not anticipate it. Our focus is therefore on identifying any trend reversal at a relatively early stage and to ride the new trend until the weight of evidence shows or proves that it has reversed.
“Technical analysis … is not concerned with the difficult and subjective tasks of forecasting trends in the economy… Technical analysis tries to identify turning points…” (Martin J Pring, Technical Analysis Explained, 4th edition, McGraw-Hill, p.8.)
“Trend-following indicators always have you buying and selling late and, in exchange for missing the early opportunities, they greatly reduce your risk by keeping you on the ‘right’ side of the market. …(By contrast) leading indicators aim to predict what prices will do next. They provide greater rewards, but at the expense of increased risk. Most investors are better at following trends than predicting them.” (Steven B Achelis, Technical Analysis from A to Z, 2nd edition, McGraw-Hill, pp.33-35.)
We hope to buy at the beginning of an uptrend at a low price, ride the trend, and sell when the trend ends at a high level. The first and most important challenge is to determine when a trend is beginning or ending. A trend is a directional movement of prices that remains in effect long enough to be identified and still be playable.
Trend-following, or lagging, indicators don’t flag upcoming changes in prices; they simply tell you what prices are actually doing (i.e., rising or falling) so that you can invest accordingly.
Changes in our signals are triggered only when a firm trend with strong momentum has been clearly established.
Most trend followers do so by scanning the share market for individual shares that display a firm trend with strong momentum. In this way they seek to better the overall market in both upturns and downturns.
Market timers are less ambitious. What is being ‘timed’ is the overall share market, rather than individual shares. As a result, without shorting in Australia, market timers cannot out-perform the market index in upswings. All timers try to do is to minimize losses during any downturn.
Our approach is designed to identify exit and entry points only when a clear trend has developed. By definition, we never get in at the beginning of a trend or get out at the top.
We don’t play the game thinking that picking tops and bottoms is feasible.
Market timers – like all trend followers – earn their profits by capturing the middle of a price trend. We never identify the trough or the peak.
It’s the middle price range that matters, as the following chart illustrates:
Because we don’t try and spot upturns until they happen, we enter the market some days after an up-trend starts. As a result, we forgo a gain that flows automatically to buy-and-hold adherents.
Equally, because we don’t try and spot reversals until they happen, we exit the market some days after a market retreat starts. As a result, we take some of the loss that invariably hits buy-and-hold adherents.
Essentially, trend following is all about foregoing some gains in a market upswing in the hope of avoiding most of the losses that would otherwise occur during a market downturn.
Occasionally, the market – rather than continuing the trend – reverses just after we enter or just after we exit. Such back and forth swings are called ‘whipsaws’.
Where this occurs soon after an exit, we can find ourselves back in the market at a higher price than we exited.
When this occurs soon after an entry, we can find ourselves in a losing position.
Our use of trailing stops means that if the market retreats by a pre-defined percentage we exit. No debate. This is all about protecting our capital.
Losing signals are part of any timing strategy. If we can make a gain in a majority of our signals, then we should be on track. Generally, the nature of our approach means that over time winning signals should more than compensate for any losing signals.
As a prominent US market timer has put it:
“The psychological challenge comes when investors who adopt a market timing strategy discover that the art and science of stock market timing is prone to error from time to time. We would suggest, as akin to a baseball all-star batting .350 during the course of a season, an all-star market timer could produce a winning trade percentage close to 70%.
Therefore, those that do adopt a market timing strategy need take a long-term investment time horizon, be prepared to lose money on at least 30 percent of their trades and after each five year interval hope to enjoy an unleveraged investment return in the neighborhood of 10% per annum …” (Jonathan Waller, President of TimingEquity Services Ltd, July 2009)