How Following Trends Can Net Big Returns

Nicholas Vardy

Nicholas Vardy has a unique background that has proven his knack for making money in different markets around the world.
[Wall St. Sign]

When it comes to clichéd wisdom, Wall Street is full of it.

Investment maxims such as “buy low, sell high” and “don’t fight the tape” are all too common.

Yet perhaps the most pedestrian of proverbs is that “the trend is your friend.”

For U.S. stock market investors, the long-term bull market trend launched in 2009 has certainly been friendly.

Trend-following investors have been able to buy an S&P 500 Index mutual fund, or an exchange-traded fund such as the SPDR S&P 500 (SPY), then ride the bull trend some 86% higher over the past five years.

It turns out being “dumb and long” the S&P 500 has trounced the greatest minds on Wall Street.

Ironically, employing a trend-following strategy elsewhere hasn’t worked very well for Wall Street’s so-called smart money.

That’s especially true for some of the most sophisticated, algorithm-based investors engaged in managed futures funds, also known as commodity trading advisers (CTAs).

These funds rely on often-complex mathematical formulas that follow the trends in the commodities, currencies and fixed income markets.

In contrast to the U.S. equity market, where the trend has been the retail investor’s friend, lasting trends in commodities and currencies have been as rare as, well, a happy Democrat in the White House.

The lack of volatility in global financial markets — and the skewing of the usual non-correlation between commodities, currencies, equities and bonds — has largely been caused by artificially low interest rates and central bank “money printing” interventions around the globe.

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That’s good for some markets like stocks and bonds.

But it’s not so good for funds that seek to profit from a portfolio based on aggressive, non-correlated trends across a wide range of asset classes.

A Light at the End of the ‘Algo’ Tunnel

For CTAs, the recent strong trends in the commodity and currency space have finally translated into some strong performance.

Plunging crude oil prices, a rising U.S. dollar and the tumbling Japanese yen and euro have reinvigorated CTAs, putting them back on track for a terrific 2014.

Many CTAs had their best month in over a decade in November. Some CTAs saw strong double-digit percentage returns — a welcome change from the last five years.

The recent gains enjoyed by several big CTA firms like AHL and Winton suggest that there is a profitable light at the end of the tunnel for these algorithm-driven, or “algo,” funds.

Building Your Own CTA Trend-Following Portfolio

The recent success of CTAs has brought trend following back into favor among professional money seeking market gains uncorrelated to the U.S. stock market.

The good news is that you can follow the same trends as the CTAs to generate robust gains via several specialized exchange-traded funds (ETFs) that don’t require complex algorithms or sophisticated computer models to understand.

In the case of what has been one of the most dominant trends of late, tumbling crude oil prices, you can take advantage of the crude meltdown via inverse oil ETFs.

By far the most popular choice for riding the trend lower in crude oil is the ProShares UltraShort Bloomberg Crude Oil (SCO).

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This fund is designed to deliver twice the inverse of the Dow Jones-UBS Crude Oil Sub-index. In essence, when crude oil prices fall 2% in a day, then SCO should rise about 4%.

Over the past six months, SCO has ridden the trend of falling oil prices higher by more than 118%. It surged 42% just this past month. Another big drop in crude oil prices on Monday, Dec. 8, sent SCO up 7.8% in just a single trading session, proving the trend in oil prices definitely has been a friend to those long SCO.

A rising U.S. dollar also has been a pronounced trend that CTAs have exploited of late. You can profit from the surging Greenback through the PowerShares DB US Dollar Index Bullish Fund (UUP).

A current recommendation in my Alpha Investor Letter newsletter, this ETF follows the U.S. Dollar Index, which in turn tracks the value of the dollar relative to a basket of the six major world currencies — the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc.

During the prior six months, UUP has captured the trend higher in the buck nicely, as the fund is up 10.2%.

The bottom line?

The return of sustained trends in the commodities and currencies space, combined with the availability of specialized ETFs, mean that you too can profit from big moves in global asset classes that are generating big profits at Wall Street’s most sophisticated CTAs.

In case you missed it, I encourage you to read my e-letter column from last week about how you can beat the traditional S&P 500 index. I also invite you to comment in the space provided below.

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