Saturday, October 13, 2007

Trend Following by Market Theme

In this chart, we decompose the S&P 500 Index (SPY) into eight of its sector components for the last week of trading. For easy comparison of performance, I have set each sector to an equivalent price at the start of the week.

Although SPY was up on the week, we see that not all sectors participated in the strength. Specifically, we see relative weakness in XLF (Financials), XLI (Industrials), XLY (Consumer Discretionaries), and XLV (Health Care). Indeed, those four sectors were down on the week.

Meanwhile, note that much of the SPY strength came from XLE (Energy), which was up about 3% on the week. Also up on the week were XLB (Materials), XLP (Consumer Staples), and XLK (Technology).

Note, interestingly, that by Tuesday the sectors had already separated themselves out by performance. The top sectors for the week were already outperforming; the worst performing sectors were already at the bottom of the heap.

You don't have to be in a trend to be a trend follower. When you notice the sectors and themes driving the market averages, you're in a good position to follow the flows of capital. Weak dollar themes and concerns over economic slowdown continue to define trends *within* the market averages.


Relational Thinking and Trading Success


High Probability Trader said...

Good post Dr. B,
you could trade with a hedge in the market by going long one sector such as XLE and hedging by going short XLF. In a similar fashion if you were trading index futures and you had a bias for big caps over small caps you could go long YM and short ER2 as a hedge.
Dr.B, do you have any posts on how you would trade a similar hedged strategy using bond futures?
Also, I was wondering from your experience working with traders, which traders were most successful in profits in relation to what type of product they traded (stock, futures, bonds, options, forex), and also which traders were most consistent with the smallest drawdowns.

Scaurus81 said...

a very intersting post.
Excuse me my bad english, but I am un italian reader.
I would like to know what you think about the book of Alexander Elder ( Trading for a living ), if you a read this book.
I have just started to study the trading and I am looking around for good books to read about this argoment.
Complimenti per il blog.

Brett Steenbarger, Ph.D. said...

Hi High Prob,

You're right; the same basic approach would apply to yield curve trading. I don't engage in that trade, however, so don't have any posts on the topic. The most successful traders, I find, trade multiple asset classes simply because they're managing so much capital.


Brett Steenbarger, Ph.D. said...

Hi Lorenzo,

I don't have any specific reactions to Elder's book, but I know that it's been very popular with readers. I like John Carter's book particularly.