Directional trends tend to persist. When a price is trending, it’s more likely to continue than to reverse. A directional trend is a drift up or down. For example, we can simply define a uptrend by observing a price chart of higher highs and higher lows. A downtrend is an observation of lower highs and lower lows. For a trading system, we need to be more precise in defining a direction with an algorithm (an equation that mathematically answers the question). The concept that directional trends tend to persist is called “momentum“. Momentum is the empirically observed tendency for rising prices to rise further. Momentum in price trends have been exploited for decades by trend following traders and its persistence is now even documented in hundreds of academic research papers. Momentum persists, until it doesn’t, so I can potentially create profits by going with the trend and then capturing a part of it.
But all trends eventually come to an end. We never know in advance when that will be, but we can determine the probability. Sometimes a trend reversal (up or down) is more likely than others. If you believe markets are efficient and instead follow a random walk, you won’t believe that. I believe trends move in one direction, then reverse, then trend again. When I look at the charts below, I see what I defined previously as “a trend”. I have developed equations and methods for defining the trend and also when they may bend at the end. More importantly, I observe them when they do bend. For example, to capture a big move in a trend, say 20% or more, we can’t get out every time it drops -2%, because it may do that many times on its way to that 20%. So, trend following means staying with the trend until it really bends. Counter-trend trading is trying to profit from the bends by identifying the change in the trend. Both are somewhat the opposite, but since my focus is these trends I observe them both.
Inertia is the resistance to change, including a resistance to change in direction. I could say then, that it takes inertia to keep a trend going. If there is enough inertia, the trend will continue. Trends will almost always be interrupted briefly by shorter term trends. For example, if you look at a monthly chart of a market first, then view a weekly chart, then a daily chart, you’ll see different dimensions of the trend and maybe left with a different observation than if you just look at one time frame.
Below I drew a monthly charge going back nearly 12 years. As you can see, the U.S. Dollar ($USD) has been “down” as much as -40% since 2002. It’s lowest point was 2008 and using my definition for trend, it’s been rising since 2008 though with a lot of volatility from 2008 to 2011. We could also say it’s been “non-trending” generally since 2005, since it has oscillated up and own since then without any meaning breakout.
All of charts are courtesy of http://www.stockcharts.com
Next we observe the weekly price trend. In a weekly chart we see the non-trending period, but ultimately over this time frame the Dollar gained 9%. The Dollar has been at a relatively low price range during this time. For those who want to understand why a trend occurs: A low currency is a reflection of the U.S. debt burden and lack of economic growth. We can only say that in hindsight. Most of the time we don’t actually know why a trend is a trend when it’s trending – and I don’t need to know.
You can probably begin to see how “the trend” is a function of “the time frame”. The most recent trend is observed in a daily chart going back less than a year. Here we see the U.S. Dollar is rising since July. I pointed out in “Interest Rates and Dollar Rising, Commodities Falling” how the Dollar is driving other markets.
The Dollar is now at a point that I mathematically expect to see it may reverse back down some. Though a trend is more likely to persist and resist change (inertia), trends don’t move straight up or down. Instead, they oscillate up and down within their larger trend. If you look at any of the price trend charts above, you’ll see smaller trends within them. It appears the Dollar is now likely to change direction at least briefly, though maybe not very much. As I mentioned in “Interest Rates and Dollar Rising, Commodities Falling”, it seems that rising interest rates are probably driving the Dollar higher. The market seems to be anticipating the Fed doing things to increase interest rates in the future. Let’s look at some other trends that seem to be interacting with the Dollar and interest rates.
The MSCI EAFE Index is an index of developed countries. You can observe the trend below. International stocks tend to decline when the Dollar rises, because this index is foreign country stocks priced in Dollars.
Below is the MSCI Emerging Markets index, which are smaller more emerging countries. MSCI includes countries like Russia, Brazil, and Mexico as “emerging”, but some may be surprised to hear they also consider China an emerging market. The recent rising Dollar (from rising rates) has been partly the driver of falling prices.
Another market that is directly impacted by the trend in the Dollar is commodities. Below we see the S&P/GSCI Commodity Index.
I am sharing observations about global macro trends and trend changes. We previously saw that the Dollar was generally in a downtrend and at a low level for years. When the Dollar is down, commodities priced in Dollars may be up. One commodity that became very popular when it was rising was Gold. When the Dollar was falling and depressed, Gold was rising. Below is a more recent price trend of gold.
I wouldn’t be surprised to see the Dollar trend to reverse back down some in the short-term and that could drive these other markets to reverse their downtrends at least briefly. Only time will tell if it does reverse in the near future and by how much.
In the meantime, let’s watch it all unfold.