It is almost the beginning of a new year and time for me to reiterate my stock market trading strategy to myself. Writing it down again improves my discipline (I think) and what better than to write it down in a public blog.
For 2022 I will continue with my basic strategy of trend following. Here are the rules:
A trend is bullish when the 10-day moving average is above the 20-day moving average and the 20-day is above the 50-day.
A trend turns bullish when the 10-day moving average crosses over the 20-day moving average at close of day. Also, the 50-day needs to be below the 10-day and 20-day.
A trend is bearish when the 10-day moving average is below the 20-day moving average.
A trend turns bearish when the 10-day moving average crosses below the 20-day moving average at close of day.
Going forward I will not have a neutral rating for trends. The above 4 rules are sufficient to execute as a plan.
Applying the above rules to S&P500 over 2021 the strategy would have returned +18% compared to the overall gain in S&P500 of +22%. This is as I write, and it does not look smart at all.
However, I use leveraged instruments with the trend following rules. For S&P500 I use SPXL which is a 3x leverage of the S&P500 index. Using the rules on SPXL would have given me +54% which is 2.45 times the returns on S&P500.
Yes, holding the index for the whole year has lower tax implications than the 5 trades I would do on the SPXL. However, the higher gains more than makes up for the higher taxes.
Note that the SPXL overall returned +101% by just buying and holding for all of 2021. So, there is an argument as to why do all this trading (5 trades) only to generate half of the overall returns.
The answer is drawdowns. Using a 3x leveraged instrument like SPXL means the drawdowns are much more severe than a standard index. In 2021 it was not too bad. There were 2 big drawdowns one about -15% and the other -11%. However, 2020 had a drawdown of almost -50%.
There is probably still an argument to just hold the SPXL if one believes that the S&P500 consists of the top 500 companies and will likely keep going up year after year.
Here are SPXL returns for the last 10 years:
2021 +101% (YTD)
2020 +9% (pandemic year)
Total 10-year return is +2762%. And there were only 2 out of the 10 years when the returns were negative. So, yes there is merit in considering buy and hold for SPXL.
However, the company that manages SPXL specifically calls out that it is not to be used in a buy and hold strategy. In fact, it has the specific word “Daily” in the instrument’s name to indicate it is a short-term strategy.
So, one has to do what one feels comfortable with. If we want to be conservative and avoid potential large drawdowns, then use the trend following. If one’s time horizon is longer and intermediate drawdowns will not cause issues, then buy and hold.
Just laying out the options and not providing any specific guidance.