SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

Trend Following: An 88 Year look at S&P 500


Many investors have become interested in trend following strategies in recent years due to the scars of living through two major bear markets since 2000. In my firm, we also believe in trend following as a sustainable method for managing the downside risk of investing in risky assets like equity index funds and ETF's. 

A principle of quantitative investing is that the more data you have, the better. Below is an example of trend following the S&P 500 with a combination of 6 to 12 month absolute momentum since 1930. Individuals interested in recreating this simulation on their own can contact me directly at jblom@lorintine.com.  A hypothetical rules-based backtest this long includes the greatest crash we’ve ever seen in US stocks where the S&P declined 80% during the great depression. Some may get distracted by the discussion on how the markets were “different” then vs. now. The objective here is only to see how well a simple model holds up on as much historical data as possible. We’re looking for robustness.

 

Portfolio 1: Momentum (Either in the S&P 500, bonds, or a combination of both based on absolute or "time series" momentum)

 

IVV1930: This is a custom built dataset of S&P 500 total returns where index data is used prior to modern day investable products like the iShares ETF, IVV, which are used when they became available.  

 

Click on all images for greater clarity.

1.png

 

Every statistic is improved, except best year, which is expected, because during positive outlier years the best a single asset trend system can really be expected to do is match the buy and hold return. The most notable improvement is the reduction in volatility and drawdown, which is a common trait of simple trend following systems like this. 35% is still a large and very uncomfortable maximum drawdown, which is why diversification is always recommended and how we actually implement these concepts in our firm for our clients. 

 

I find it interesting to actually zoom in on the great depression period because backtesting does a great job of simulating everything about past performance EXCEPT how it would have actually felt to live through it. Cliff Asness says it well in his description of what he calls time dilation:

 

"Well the single biggest difference between the real world and academia is - this sounds overly scientific - time dilation. I’ll explain what I mean. This is not relativistic time dilation as the only time I move at speeds near light is when there is pizza involved. But to borrow the term, your sense of time does change when you are running real money. Suppose you look at a cumulative return of a strategy with a Sharpe ratio of 0.7 and see a three year period with poor performance. It does not phase you one drop. You go: “Oh, look, that happened in 1973, but it came back by 1976, and that’s what a 0.7 Sharpe ratio does.” But living through those periods takes — subjectively, and in wear and tear on your internal organs — many times the actual time it really lasts. If you have a three year period where something doesn’t work, it ages you a decade.  You face an immense pressure to change your models, you have bosses and clients who lose faith, and I cannot explain the amount of discipline you need."

 

2.png

 

 

Based on my decade of experience in working with investors, I can imagine the fear being so strong during this kind of period that investors would have bailed on the trend system even when it was doing its job of preserving capital. Certainly there was something else in the world that was making money during this period for investors to compare performance to and chase after the fact returns. When it comes to stocks, as prices go lower and therefore future expected returns increase…for some reason investors become less interested.  Perhaps this would be different if stock prices were quoted in yields instead? I don't know, but behavioral biases are actually part of the academic explanation of why trend following has held up for so long, including well after its discovery.

 

In more recent history, we saw a similar stretch in markets from 2000-2009, now referred to as “the lost decade” for the S&P 500. Trend following performed extremely well during this period, probably even better than should be expected during the next bear market due to how relatively stable both the up and down trends were during this period and also how strong the performance of US aggregate bonds was as a risk-off asset. 

 

3.png

 

Trend following does tend to under perform during strong bull markets like we've seen since 2010, so investors must manage expectations accordingly. The only way to get 100% of the upside is to accept 100% of the downside. Also, trend following is going to generate turnover that will make it less tax efficient than buy and hold and should therefore be favored in tax advantaged accounts for high income earners. All of these things are what we can assist clients with in designing a comprehensive asset allocation plan that suits your personalized situation and needs. 

 

Jesse Blom is a licensed investment advisor and Vice President of Lorintine Capital, LP. He provides investment advice to clients all over the United States and around the world. Jesse has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™. Working with a CFP® professional represents the highest standard of financial planning advice. Jesse has a Bachelor of Science in Finance from Oral Roberts University. Jesse oversees the LC Diversified forum and contributes to the Steady Condors newsletter. 

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • Traditional or Roth Retirement Account?

    When US investors save for retirement, there are many important decisions that have to be made including which investments to use as well as which type of accounts to fund. Tax favored retirement accounts such as 401(k)’s and IRA’s should be utilized to the maximum extent possible because of the opportunity for tax advantaged growth.

    By Jesse,

    • 0 comments
    • 171 views
  • My Favorite Investing Books, Blogs, Papers, and Podcasts

    There are so many excellent sources of investment education available today that I thought a short post about some of my personal favorites could be beneficial. Below are different forms of content that have been particularly impactful to my investment philosophy, and they are not in any specific order.

    By Jesse,

    • 0 comments
    • 374 views
  • Go For Gold! The Business Behind The Dazzle

    The price of gold is often in the news—sometimes it's rising, and other times it's dropping but for the most part, it has been on a steady increase for many years. It is certainly worth more now than it did twenty years ago. When its price is on the rise, we may have thought about the benefits of selling our gold for profit and making some passive income from it.

    By Kim,

    • 0 comments
    • 242 views
  • Using Bullish Calendar Spreads to Profit on MSFT Stock

    A calendar spread is an income trade where the trader sells a near term option and buys a longer-dated option with the same strike price. Usually this is done with monthly options, but it can also be done with weeklies. They are long volatility trades so can be a nice addition to a portfolio as a way to offset some short vega.

    By GavinMcMaster,

    • 0 comments
    • 457 views
  • 3 Principles to a Successful Investment Experience

    Although not an exhaustive list, what I’ll present in this article are three core principles that overwhelmingly stack the odds of a successful long-term investment experience in your favor. These three principles are asset allocation, diversification, and rebalancing.

    By Jesse,

    • 0 comments
    • 343 views
  • Important Tips For First Time Currency Traders

    Diversifying your portfolio is important for all investors, and currency investments are a great way to do that. However, there are a lot of misconceptions and common mistakes that first time currency investors make, and this leads to big losses.

    By Kim,

    • 0 comments
    • 368 views
  • Iron Condors or Short Strangles?

    In my early option trading days, I favored selling iron condors over selling strangles. I thought that selling a strangle was too risky because the potential loss was “undefined”. I thought this made sense because this is what I’d hear from other people that were more experienced than I was.

    By Jesse,

    • 0 comments
    • 1,799 views
  • How To Be A Successful Day Trader From Home

    The good news is that if trading is your passion, then it’s possible to become a successful day trader and work from home. However, it’s not as easy as setting up shop and jumping online. There are specific steps and processes you need to have in place if you’re going to be able to make a living for yourself and have a bright career and future.

    By Kim,

    • 0 comments
    • 479 views
  • 3 Key Pieces Of Advice For New Traders

    These days, everyone claims to be an ‘expert’ on absolutely everything. Apparently, it only takes having a Twitter account to be a seasoned expert on any given subject; all in all, the Internet is full of nonsense. It’s becoming harder and harder to find legitimate answers amongst the quagmire of false information online.

    By Kim,

    • 0 comments
    • 508 views
  • Why New Traders Fail

    Our first advice to new traders is: "Learn First, Trade Later". The markets will always be there, but if you start trading without proper fundamentals, your capital will be gone very fast. The barrier to enter trading is so low today, commissions are near zero, and the whole trading game looks very promising.

    By Kim,

    • 0 comments
    • 694 views

  Report Article

We want to hear from you!


How donyou backtest your strategy?İt is like portfolio visualizer but more long time period.

Share this comment


Link to comment
Share on other sites


Your content will need to be approved by a moderator

Guest
You are commenting as a guest. If you have an account, please sign in.
Add a comment...

×   Pasted as rich text.   Paste as plain text instead

  Only 75 emoji are allowed.

×   Your link has been automatically embedded.   Display as a link instead

×   Your previous content has been restored.   Clear editor

×   You cannot paste images directly. Upload or insert images from URL.

Loading...

Options Trading Blogs Expertido