Trend Trading - Stock Market Trends Are Your Friend


Today we look at finding ways to identify the mutual funds with the best odds for outperforming the market.

One common approach to find mutual funds that are going to go up is to buy funds that are already going up, that is in a upward trend. As simple as this sounds it actually works. Newsletters have been selling versions of trend trading for years. Select the sector funds with the best recent strength, and hold them until they drop out of the top rankings, and switching them out for another one.

But trend trading is not as simple as buying one of the mutual funds on the top ten list from last year. Despite all the hoopla you see each year in the financial press touting the previous year’s top performing funds, that’s a sucker’s bet. Holding mutual funds for a year based on the previous year's performance actually lags the markets. You need to look at a shorter time frame to do trend trading, and plan to hold them for a shorter time frame as well.


For example, one of the top mutual fund advisory services ranked in the Hulbert rankings for the last 20 years does exactly that. They tell you exactly how they do it, and yet after all these years they still outperform most of the other wizards.



It turns out there’s a sweet spot for trend following with mutual funds. If you are investing in mutual funds, since you have to make trades the next day, you need to identify trends that will last for days, or weeks , or months. In our work, we’ve seen that the sweet spot tends to be in the range of 1-4 months. That’s a key part of the problem with the Morningstar ratings, they weight the performance for up to 10 years. While that may be great a way to characterize the performance of the fund manager, it is useless from a trend following perspective.

For example, there is a Fidelity Select System (variants of this have been published for years). Simply take the Fidelity Select family of funds, rank them according to their one month percentage change in value, and choose the top one to buy. Hold it for at least 30 days, and if it is no longer the top ranked fund, exchange it for the one currently ranked at the top. You can do a variant of this for free on Fidelity’s site, just go to

http://content.members.fidelity.com/mfl/catperf/0,,ST|SECTOR|nld_1mn,00.html

and sort according to 1 month performance. Put your money in the top fund, hold it until the beginning of the next month, and rank them again (these rankings are only updated once a month). This has historically returned about 20% compounded annually (although it has also had drawdowns as steep as 50% as well. Before you actually invest money in this system, read tomorrow’s key factor on volatility). Find more on this Fidelity Select strategy here.

Now the mutual fund companies know this works. But they don’t want you switching your money around, because they only get paid if they are holding on to your assets. They don’t have to be making you any money to get paid, they take their fees (anywhere from 0.4% to 3% or more of your money), and it doesn’t matter if your account goes up or down in value.

That’s why the fund companies and the brokerage fund supermarkets now charge Early Redemption Fees (ERF’s) for you to take your own money out of your own account if you haven’t had it in your account long enough.

They count on the fact that most people are lazy, or busy, or don’t know better, and if they get you to keep your money in their hands for 90 days, more than likely you will take years to move it out. If you try to take your own money out before that, they will charge you 1-2%.

Now they’ve made the game that much harder for the average investor. But can you still beat the indexes?

Short answer is Yes! Our history says you can (take a quick peak at our current Performance page to see the up to date numbers).

We’ve come up with a couple of systems that get around the roadblocks that the funds companies have put up. We designed these systems around their minimum holding periods, and we stay within the letter of their requirements. But, using a version of the relative strength rankings that have worked for years, we simply switch every 90 days. The Select system allows us to switch a fund after 30 days, which reduces volatility somewhat.

Tomorrow’s Installment: Volatility is your Enemy.

We’ve designed fund trading systems to take our Keys to Success with Mutual Funds, and deliver performance that has beat the market in real time since their inception. Click here to learn more about the Fundztrader systems.