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Recently I completed the reading of “Trader Vic on Commodities” and was reintroduced to the S&P Diversified Trends Indicator. This indicator is used to allocate long and short positions in a diversified portfolio of Commodities and Financial futures.
This means that investors do not buy into a ‘black box’, but instead invest in a transparent investment strategy. “In more than 40 years on Wall Street, I have learned that discipline determines the long-term success of an investment strategy. Clear rules on how and where to invest are therefore absolutely vital to that success,” explains Wall Street legend Victor Sperandeo, who developed the disciplined, transparent investment approach of the S&P DTI. While it would take quite a bit of money to trade all the futures in the S&P-DTI you could utilize managed futures funds such as those available at Rydex.
While delving through the book and the Standard and Poor’s site on the DTI, I came across the simple formula they use to determine trends in futures; a 1.6 times weighted moving average. The other very interesting fact is simply weightings (i.e. % weight in each market) is determined on an annual basis only. The average is applied to a monthly chart and moves from long to short or short to long take place only once a month. In other words regardless of your positions you can only move in the first week of the month. Talk about trading volatile markets in a relaxed manner – it’s the diversification that makes that possible. Whether stocks or futures, trends do exist, substantially so at times, and the objective is to capture a major portion of the move regardless of direction.
This week let’s take a look at this 1.6 times weighted moving average and apply it to a stock market index and see how it works. The average is calculated monthly at the end of each month and activity occurs on the first trading day of the following month. If price is above our moving average we buy, if it’s below we sell. If we are already long and price remains above the average we sit and conversely if we are short and price remains under the average we sit. That’s it, no other conditions, no slopes or rates-of-change. First a chart of the Dow Industrials with the 1.6 weighted moving average.
With our requirements laid out above, the picture certainly looks like whipsaw city doesn’t it? Well let’s back test and see what happens; remember we only move once a month based on the close the previous month in relation to the moving average. Take note from the picture above; this simple methodology has been short the Dow Jones since November.
That is certainly great performance over a 78 year period. To put it in perspective, do you recall the rule of 72 which states; divide your return into 72 the result is the number of years for your money to double. Dividing 72 by 13.76; results in doubling your money every 5.232 years.
The purpose however today is not to attempt to devise a trading system for the Dow Jones Industrial Average. No optimization has taken place either by me or Standard and Poor’s, the return shown might be better with a 1.3 or a 1.9 weighting to the moving average. The real purpose of today’s letter is to discover and think in terms of possibilities.
What if you employed a methodology as simple as this one, utilized in a diversified portfolio of sectors, ETF’s, Commodities, or a combination of some sort? Suppose you were to weight, for instance, country ETF’s and/or currency, by that countries GDP and apply such a long/short philosophy across all country ETF’s. It’s certainly an interesting way to approach a diversified portfolio in a global economy.
For fun, I’ve run this particular indicator against the 435 ETF’s currently in our database (ETF’s are only included after a minimum of 1 year of trading). The current posture shown does not mean that the indicator has just gone long/short on 3/3. The posture may be and often has been the same for many months. Get that list Here!
S&P DTI performance: charts from the S&P website:
