Trend Following Strategy With Etf: No Crash, Less Cash

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Trend Following Strategy With Etf: No Crash, Less Cash. Proponents of market timing strategies promise equity investors heaven on earth: high profits with minimal risk. Fairvalue tested the most popular trend following strategy with exchange-traded index funds (ETF). The results show what investors can really expect from this concept. There is hardly an investor who does not dream of lush returns, but at the same time wants to be spared price fluctuations and stock market crashes. Ever since stocks have existed, investors have been looking for such a super strategy – and every now and then at first glance it looks as if the stone of the stock exchange has finally been found.

The only problem is that no investor knows the future . How the courses will develop is and remains unknown, even if some media and the “experts” appearing in them regularly suggest something different. For a successful timing strategy, however, it is not at all necessary to precisely predict the turning point in the markets. It would be enough to sell somewhere near highs and then re-enter at a lower level later when the market is back on the uptrend.

Trend following strategy with the moving average

So-called trend following strategies pursue this goal. They are based on indicators that can be calculated from past prices. Trend-following indicators are intended to signal to investors when to enter a market and when to exit again. The most commonly used indicator is the simple moving average , also known as the Simple Moving Average (SMA). The basic moving average equation is simple: The past prices of an index or a security are added for any number of days – ending with the most recent price – and then divided by the number of days. This procedure is repeated every day for the same number of days, so that the oldest course is dropped and the newest is added. This creates a smooth price trend that more or less fades out the daily price fluctuations depending on the length of the selected time interval.

Impressive studies on trend following strategies

There is a number of research that shows that moving averages based trend following strategies work pretty well. According to this, the returns are sometimes those of a buy-and-hold strategy in which an investor remains invested in a security throughout around the same time, worth volatility ( volatility ) and the maximum losses in value (measured from a high to the next low point) were considerably lower.

Product costs, transaction costs and taxes

Neither he nor we have included product costs, transaction costs and taxes in our calculations. Faber takes the position that one can neglect the transaction costs because buying and selling exchange-traded index funds (ETF) does not cost much anymore. However, this is only correct if investors independently place their securities orders with a cheap online broker and trade ETFs that map liquid asset classes. In the case of a branch bank, on the other hand, the trading costs would be noticeably significant.

While the costs of securities trading can be reduced simply by changing the securities account provider, investors cannot avoid the tax. The tax authorities hold out their hand every time investors make a profit from the sale of securities. Withholding tax and solidarity surcharge add up to 26.375 percent , which are deducted from the income. Those who pay church tax have even higher deductions. Of course, investment income always has to be taxed at some point. But the point in time plays a role in the return. Investors who essentially only pay capital gains tax at the end of the investment period, as in a buy-and-hold strategy, achieve a higher compound interest effect. On the other hand, if taxes are repeatedly deducted during the investment phase due to frequent shifts, the compound interest effect melts away.

Estimation of the negative tax effect in trend following strategies and Recommendation

It is a complex undertaking to calculate the negative tax effect for a trend following strategy. In addition, the actual tax burden is individual in many cases.  The disadvantageous tax effect of the trend following strategy results from the hypothetical comparison with the tax burden that would have arisen if the total profit had only been taxed at the end of the investment period. According to this calculation, the loss of return due to early tax payments and transaction costs averages 0.8 percentage points per year. Basically, the distribution of profits has an impact on the result. The earlier taxes are deducted during the investment period, the worse the result will be. The eight asset classes had different price developments. However, by and large, the estimate of the negative tax effect is transferable to the overall portfolio in our opinion. Assuming a discount of 0.8 percentage points on the annual average return of the trend following strategy, none of the market timing concepts performed better than the buy-and-hold strategy over the entire period under review.

A trend following strategy with moving averages is not a ducat donkey. Higher returns than with a buy-and-hold strategy are not very likely. In the past, they were only possible in a few investment periods in which there were major stock market crashes. In terms of the return in relation to the risk (Sharpe ratio), even a very well diversified ETF portfolio can be improved with market timing. The trend-following strategy showed its strengths particularly in the case of prolonged price falls, which should be of benefit to anxious investors. A buy-and-hold strategy is significantly riskier. Anyone who regards trend-following strategies as an effective risk management system and is prepared to accept discounts in return can definitely consider this concept. It is ideal for investors who do not have the nerve to stick to a buy-and-hold strategy even in a crash. However, it is likely to gnaw at the psyche of many investors if they perform worse than the market for years with a trend following strategy and the gap increases from year to year. Not everyone can take that either.

Hello, I have been working as an investment consultant and author for more than 20 years. I love what I do and I have enriched everyone around me. A lot of money is not important, the main thing is how you use the money.

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