TREND FOLLOWING

applied to equities and ETFs

18 December 2013 Bloomberg London

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

Riccardo Ronco
Biography

Riccardo Ronco is the head of technical analysis at Aviate Global in London.

Mr. Ronco follows large- and mid-cap European and U.S. equities, paying attention to domestic and
foreign equity indices, currencies, commodities, and interest rates. As a medium-term trend follower,
his approach is strongly quantitative in nature; particular attention, however, is devoted to identifying
reversal patterns characterized by excessive consensus among investors.
Mr. Ronco brings more than 15 years of experience in trading, quantitative analysis, and teaching
technical analysis in the United Kingdom and Italy. Prior to joining Aviate Global in April 2010,
Mr. Ronco worked for Credit Agricole Indosuez, Banca Intesa Group, and Banca AntonVeneta
(Monte Paschi Group) and FBR Capital Markets.
He is a frequent guest on CNBC Europe and other European media outlets. A member of the
Society of Technical Analysts (STA) and the Market Technicians Association (MTA), Mr. Ronco was a
speaker at the International Federation of Technical Analysts (IFTA) 1998 conference in Rome and
Beijing (2011).
His work is mentioned in the book Capital Market Revolution: The Future of Markets in an Online
World by Patrick Young. Mr. Ronco received his degree (with honors) in economics from the
University of Turin.
He currently holds Chartered Market Technician (CMT) Level 1 and 2 diplomas.

18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

Emotional = Irrational
Human emotions affects ones decision making process
Investors are everything but rational: Hope, Greed, Fear, Despair investing cycle

18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

Why Trend Following?

Information: perceived in a different way by different actors (different needs and
time horizons for investing)
Cognitive Biases: Loss Aversion, Disposition Effect, Outcome Bias, Anchoring,
Bandwagon Effect, Belief in the law of small numbers
People are prone to making SYSTEMATIC ERRORS in circumstances of uncertainty
ALL this creates trends (evident ex post, obviously)
Market movements are, therefore, the result of investors' irrationality that is
repeated systematically over and over
How do we deal with this? By doing the opposite of what the majority does

LET YOUR PROFITS RUN

CUT YOUR LOSSES SHORT
THINK IN TERMS OF PROBABILITIES

18 December 2013

What is Trend Following? Its a Plan

TREND: sustained changes in prices in the same direction (usually after consolidations)
FOLLOWING: detect these changes, jump on board and hold as long there is a change in the
opposite direction
PRICE: MAIN VARIABLE (other variables can be used to filter price info however price is THE
objective point of reference)
REACTION no PREDICTION (hardest part to accept due to Outcome Bias): we do not deal with
certainties on the result but only with probabilities. We do not know the result of the next
trade: possibly, it will be a (big) win but, probably, it will be a (small) loss.

18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

Basis for All Successful Trading

Trade with an EDGE: use a model/s with POSITIVE Mathematical Expectancy over long term to
avoid the Outcome Bias, trade well
RISK Management: portfolio/sector risk, initial stop loss, trailing stop, position sizing
f(volatility, correlation with other markets), target specific level of volatility that you are
comfortable with... to stay in the game!
KISS: SIMPLE algorithms (not simpler) to make the system ROBUST
CONSISTENT: discipline built on confidence, confidence built on robust approach and
understanding of the process (most important factor), follow the process
Hence our job is:

NOT to miss those trends!

18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

the Most Important Thing About Losses

"A loss never bothers me after I take it,
I forget it overnight. But being wrong, not
taking the loss - that is what does damage to
the pocket book and to the soul.
Jesse Livermore

18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

Expectation (a.k.a. the edge) > 0

Expectation = (%W x AW) (%L x AL)

where
%W = Winning Percent
AW = Average Winner
%L = Losing Percent or (1 - %W)
AL = Average Loser
for Expectation = 0 we have the Breakeven Line curve

Y = (1 X) / X
where
Y = AW / AL or WIN/LOSS ratio
X = %W
18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

Expectancy Curve Nick Radge

10
9
8

Profitable

WIN/LOSS RATIO

7
6

Breakeven Line

5
4
3
2
1

Unprofitable

0
10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% 95%

WIN %
18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

Number One Problem: Drawdowns

We have a system that cuts the big losses...
Lots of small losses (false breakouts) will balance out lots of small gains...
We are left with those LARGE WINNING TRADES when markets do trend (fat tails)
However, the length of a losing streak WILL affect you, psychologically and emotionally
=ROUND(LN(Nr. Trades) / -LN((1 (% WIN / 100))),0)

Example: 40% WIN and 10,000 trades 18

After 10,000 trades there is 1 chance to have 18 consecutive losers
18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

10

Money Management: Length of a Losing Streak

90
80
70

80-90

60

70-80
60-70

50

50-60

40

40-50

30

30-40

20

20-30

10

10

18 December 2013

9500

9000

8500

8000

7500

7000

6500

99

0-10

% WIN

10000

TRADES

6000

70
5500

5000

4500

4000

3500

3000

2500

2000

40
1500

1000

500

10-20

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

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Money Management : Fixed Fractional

RISK on EACH TRADE can impact how we trade and think (100 starting capital)
100
90
80

% risk / loss

70
1

60

50

3
4

40

30
20
10
0
1

9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97

Consec.
Losses

If our %WIN is 40% then, in the long run, we WILL get 18 losses in a row
If we risk 4% on each trade, that will be enough to lose 50% of our equity even with FF
18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

12

Putting All Together

We need a system with a POSITIVE expectancy, think long term
Secret of success? Follow the rules, consistently (otherwise whats the point?)
The more we trade, the higher the probability of a long sequence of losses
the biggest drawdown is always AHEAD of us
Knowing your % WIN will help choosing a sustainable level of Fixed Fractional,
how much you want to RISK on each trade of your total equity

We cannot control the outcome of the trade

but we can control its SIZE before and during the trade
consider filters on volatility and market trends to target better levels of risk

18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

13

Moving Averages vs Channel Breakouts (CBO)s

Strategies that are LONG ONLY, Profits and Losses always reinvested
No commissions, slippage, taxes (low trading frequency anyway)
When in cash NO interest added (lets see the system for what it is)
Using SIMILAR lengths in these models, the SHAPE of equity lines is
SIMILAR so there is no real advantage in using one model or the other
No need to over-fit on a SPECIFIC stock/sector: some models work great on
certain stocks and poorly on others hence

Focus at PORTFOLIO LEVEL

18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

14

Moving Averages vs CBOs: Anheuser Busch ABI BB

18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

15

Moving Averages vs CBOs: Inditex ITX SQ

18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

16

EuroStoxx 50 TR: One Way to Avoid Overfitting

LONG ONLY No Comms, taxes, no reinv. cash Start 1/1/1993 Initial Capital 100K
18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

17

S&P 500 vs 10-month SMA Long only

LONG ONLY USD 1,000,000 No Comms, taxes, no reinv. cash Start 1/1/1969
18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

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Profitability over different m.a. lengths

LONG ONLY USD 1,000,000 No Comms, taxes, no reinv. cash Start 1/1/1969
18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

19

MSCI Japan TR USD vs 10-month MA

LONG ONLY USD 1,000,000 No Comms, taxes, no reinv. cash Start 1/1/1970
18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

20

Eurostoxx 50 TR vs 10-month MA

LONG ONLY EUR 1,000,000 No Comms, taxes, no reinv. cash Start 1/1/2000
18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

21

Eurostoxx 50 stocks vs 10-month MA

LONG ONLY EW EUR 1,000,000 No Comms, taxes, no reinv. cash Start 1/1/2000
18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

22

STOXX Europe Large Cap 200 stocks vs 10-month MA

LONG ONLY EW EUR 1,000,000 No Comms, taxes, no reinv. cash Start 1/1/2000
18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

23

DJ Stoxx 600 sectors TR vs SMA 10 - Long only

1400

1200
PFOLIO

1000

MM10_SXXR

b&h

800

600

400

200

1/5/13

1/9/12

1/1/12

1/5/11

1/9/10

1/1/10

1/5/09

1/9/08

1/1/08

1/5/07

1/9/06

1/1/06

1/5/05

1/9/04

1/1/04

1/5/03

1/9/02

1/1/02

1/5/01

1/9/00

1/1/00

1/5/99

1/9/98

1/1/98

1/5/97

1/9/96

1/1/96

1/5/95

1/9/94

1/1/94

1/5/93

1/9/92

LONG ONLY EW Monthly Rebalance No Comms, taxes, no reinv. cash Start 1/1/1992
CAGR: B&H 8.8% MM only SXXR 12.30% MM 10 on EW Sctr Pfolio 11.27%
18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

24

TF on Different Asset Classes Using ETFs

Buy when monthly CLOSE > 10-month SMA

Sell (and move to cash) when monthly CLOSE < 10-month SMA
Trade once a month, at the end of the month
No commissions, taxes, slippage but NO interest when in cash
Using total return series for:
S&P 500
EAFE
U.S. 7-10 Year Gov
US REITs
Commodities

18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

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18 December 2013
Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

Strategy
CAGR
Ann. St.dev
Mod Sharpe

IVY (blue)
7.47%
6.56%
1.14

SPY (red)
4.40%
15.40%
0.29

01/07/2013

01/02/2013

01/09/2012

01/04/2012

01/11/2011

01/06/2011

01/01/2011

01/08/2010

01/03/2010

01/10/2009

01/05/2009

01/12/2008

01/07/2008

01/02/2008

01/09/2007

01/11/2006
01/04/2007

01/06/2006

01/01/2006

01/08/2005

01/03/2005

01/10/2004

01/05/2004

01/12/2003

01/07/2003

01/02/2003

01/09/2002

01/04/2002

01/11/2001

01/06/2001

01/01/2001

01/08/2000

01/03/2000

01/10/1999

01/05/1999

01/12/1998

Mebane Faber Ivy Portfolio: EW, Monthly Rebalance

350

300

250

200

150

100

50

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TF applied to ETFs: US Risk On - Off

LONG ONLY 2 etfs ROTATION No Comms, taxes, no reinv. cash Start Jan 2003 @ 100
18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

27

TF applied to ETFs: EU Risk On - Off

LONG ONLY 2 etfs ROTATION No Comms, taxes, no reinv. cash Start June 1999 @ 100
18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

28

TF for Equities/Bond Balanced TR Fund

LONG ONLY EQ/BND ROTATION No Comms, taxes, no reinv. cash Start June 1999 @ 100
% invested in bonds decided by trend of each stock (from 100% to 0%)
18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

29

Best books on TF (a.k.a. Your Christmas List)

Andreas F. Clenow Following the Trend: Diversified Managed Futures (Wiley Trading)
Nick Radge - Unholy Grails - A New Road to Wealth
Andrew Abraham The Trend Following Bible: How Professional Traders Compound Wealth and Manage
Risk (Wiley Trading)
Curtis Faith - Way of the Turtle: The Secret Methods that Turned Ordinary People into Legendary Traders
Michael W. Covel - Trend Following: Learn to Make Millions in Up or Down Markets
Michael W. Covel - The Complete Turtle trader: The Legend, the Lessons, the Results
Mebane T. Faber - The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets
Anthony Garner - A Practical Guide to ETF Trading Systems: A Systematic Approach to Trading Exchange
Traded Funds
Van K. Tharp - Trade Your Way to Financial Freedom

18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

30

Information
Aviate Globals technical ratings use specific return targets; returns are not guaranteed and are used for illustrative purposes only.
Chart sources: Bloomberg and Aviate Global LLP.

This note is circulated to you as a client of Aviate Global LLP. Please note that the views contained within may have been disclosed earlier today to some clients
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18 December 2013

Riccardo Ronco +44 20 7233 3245 rronco@aviateglobal.com

31