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Lately I’m hearing that many people are not making money trading the UK stock market. It’s not surprising, the FTSE 100 has gone sideways since May this year and because most people use trend-following systems when a trend does not persist – profits are hard to come by. However, if you are not a trend follower there is money to be made from the market’s sideways movements.
My portfolio was up 2.8% in November against a 1.9% fall in the FTSE 100 and so far in December I’m down 0.4% against a 2.8% drop in the FTSE 100. I managed to beat the market by adopting a strategy that is designed to profit from a non-trending market, when this strategy is combined with my dependable sentiment indicator I can tell you with a great deal of certainty which way the FTSE 100 is heading.
Sentiment was bullish until 26th November and I made money on the way up as my portfolio was net long. I then I reduced my long exposure after the 26th November when the FTSE became overbought. I did this based one of my own indicators – the34-day BTI, this is an indicator that measures 2nd degree sentiment, it recorded an extreme in bullish sentiment alerting me to lighten my long exposure. This condition occurs when the FTSE is near a top. The second signal came on 2nd December when my sentiment indicator turned bearish. As you can see that was a good signal, the bears have been in control ever since.
I’m not claiming it’s easy to make money from the stock market but if you want to stand a good chance of consistently beating the market you need a reliable system that is designed to buy low and sell high. The probability of making a profit with this approach is high when the market trends and high again when the market goes sideways.
There are two typical types of traders, the trend followers and the contrarians. The trends followers use technical tools like moving averages to find a trend. Once they confirm a trend they get on board and stay on board until the trend changes, this method works well when the market trends for long periods of time. An example was seen between November last year and May this year when the FTSE 100 was in a nice uptrend with good momentum. However, this is not always the case. In fact I would say that half of the time the stock market does not trend but goes sideways so people using a trend following approach will find they are always late to get in and out, hence the chance of making a profit with this approach is low. By the time a trend following system gives a buy signal the trend will be well underway. Similarly, the trend following system will not give a sell signal immediately after the market turns down, the signal will be given when the downtrend is well underway. This means a trader will catch only a small portion of the trend and then any money made during these trending periods will be lost when the sideways periods prevail. That’s why it’s hard to consistently make a profit using a trend following approach.
The contrarians however, and I am one of them, buy low when the crowd is scared-to-death and sell high when the crowd is piling in with high hope for further gains ahead, it’s at times like these when emotion is extreme and the markets present the best opportunities to trade against the trend. John Templeton, one of the greatest investors of all time once said “The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell”. He was right, you don’t become a multi-billionaire by chance and you can only make serious money by buying low and selling high.
So why in this case would people use trend following strategies? My answer is because they don’t have a clue where the market is heading. If you do not understand the stock market your only chance of making money is by catching a trend and merely hoping that it lasts as long as possible. I think it will be a tough trading year next year where not many people will make money and I’m anticipating a sideways market throughout most of 2014. Only the most astute and skilled traders and investors who have a deeper understanding of the markets will succeed in an unyielding, non-trending environment.
Thierry Laduguie is Market Strategist at www.bettertrader.co.uk
