Should we follow the trend, or exit trades early?

Jan 30, 2024


VTS Community,

Another week begins, and the market appears perfectly comfortable remaining calm.  Now we're not complaining, we are definitely profiting nicely from this given we are net long equities with leverage and net short Volatility.  However, an interesting phenomenon happens to investors when the market cooperates for this long.

People get increasingly uncomfortable the more stable the market is

I can't tell you how many emails I've received with people asking whether we should manually exit our positions even though the Volatility metrics are pointing to remaining allocated.  We've basically been allocated to QLD, SVXY, and SPY since last November 1st without exiting.

Here's the 2x Nasdaq QLD which we've held for a LONG time now:

It's a tactical strategy with "Volatility Targeting"

The way the strategy works is that we use Volatility metrics to filter out different Volatility regimes and then we only allocate to the most advantageous security given the current market environment.  The trade dials in every email will point to where we're currently at.

The important part for today's discussion is, we don't exit any positions until the Volatility metrics themselves dictate that we do so.  It's the same for all three of our ETF strategies but taking the Defensive Rotation Strategy as the example today, we will only exit the QLD if the trade dial points to either VGLT Bonds representing an even lower Volatility regime, or into XLU Utilities if Volatility starts increasing.

Until one of those two signals flashes we just chill out and hold the QLD


Should we exit and take profit early?

Long term stability in the market always brings up that interesting question.  If the trade has reached a certain level of success  (as this current one has)  should we manually override the signals and exit early?

It's actually a difficult concept to represent with data given that the difference between a successful trade and an unsuccessful trade is so large.  What I've done is create a table showing the 20 longest streaks where we held the QLD uninterrupted.  Let's see if we can learn a few things analyzing this.

Top 20 longest QLD streaks:

We're on our 2nd longest streak ever

As you can see, we are currently in the 2nd longest streak ever which if we include today it's at 60 days.  Let me break down what those columns mean first, and then we'll try to reach a conclusion of whether we should exit now or stay the course.


Rank  -  This is just what position the streak is out of 20


Date  -  From entry of the position to the eventual change of Volatility regime and forcing an exit to a new position.


# of days  -  Self explanatory, how many days did the streak last.


Streak return  -  This shows what the gain of that position was for the entire life of the trade.


Next position upon streak ending  -  This shows which side of the Volatility shift it happened.  Remember, VGLT Bonds is when Volatility goes so low that we exit QLD, and XLU Utilities is when Volatility rises and pushes us into safety on the high side.


Peak return minus end return  (giveback)  -  This is an interesting stat and gets us a little closer to answering the question.  This is showing the difference between the high water mark of profit during the streak compared to the eventual exit return.  What you'll notice with tactical strategies is, there's typically some "giveback" at the tail end of a streak.  Remember, we need the market to change in order to be kicked out of the trade.  If it goes the VGLT direction it tends to be more mild.  However, if it goes the XLU or even Cash side then sometimes that kick is stronger and you give back some of the gains.  Unless you have a crystal ball and know exactly when to exit, giveback just comes with the territory of being an investor.  No strategy no matter how successful can call the absolute tops and bottoms of anything.


% of streak where peak profit occurred  -  Another interesting piece of data is at what point in the streak did that peak profit happen.  Obviously profit takes time to wind up so typically we will see the peak profit being a little closer to the tail end.  Now that's not always the case, you can see a few times it was actually just a losing battle the entire trade.  Most of the time though peak profit takes time to build towards.



MEDIAN averages and what it all means

Remember median represents the exact middle value in a series of values.  The reason I use median instead of mean in this case is due to the rather large gap between some of the data points.  We don't want to have the extreme readings tainting our data set so median is the best fit.

-  The typical streak averaged 35 days

-  Median return was 7.72%

-  We typically exited to safety with XLU Utilities on the regime change

-  We gave 6.44% of the peak return back at the tail end

-  Peak return happens late in the cycle at 87% of the streak


My final conclusion:

For me personally, and granted this conclusion is also assisted by my 18 years experience with Tactical Rotation style Volatility Targeting, but you are better off staying in the trades as long as the trend holds.

Looking at the table it may be tempting for people to think that if we just exit a little early we may be able to avoid some of that giveback right? 

Maybe if you capped your gains at 10% and then exited there would be some of those trades that would have been better off.  Data wise, that's true and the table shows it.  However, it will also mean that you're never going to get a truly successful trade that makes a great year a great year.

Remember our Defensive Rotation Strategy was up over 80% last year:

A great year is simply not possible if you exit early and cut off the tops of every good trend before you even get to ride it.  There's no doubt in my mind that remaining in the trend for as long as it lasts is the best thing to do.  The data backs that up, and intuitively it makes sense as well.

However...  That does mean that emotionally investors just have to accept the reality that sometimes you will give back some, or unfortunately on rare occasions ALL your gains when the trend reverses. 

It's a real gut kick when it happens, but fortunately the benefits to riding a long term trend far outweigh those short term givebacks.

The trend is our friend, and we will remain in our positions for as long as the market cooperates.  Patience and the law of large numbers is on our side

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