Investors often fail to evaluate investment results in the context of the market environment. No two investment years are equal; some calendar years provide greater opportunity to make money in certain investments than others. When judging investment results, it is important to consider the performance of an investment relative to market activity.
Long-only stock investments are typically evaluated (and rightfully so) against a long-only benchmark, such as the S&P 500 Index. Multidimensional investments such as the Lexington Keystone trading program, on the other hand, have the ability to profit from both rising and falling prices. The investment strategies employed by Lexington Asset Management seek to generate returns from sustained directional price moves, either up or down, in the futures markets, forward markets, and cash markets. Therefore, when evaluating the performance of the Lexington Keystone investment program, it is relevant to quantify the magnitude of directional price moves from markets contained within the Keystone portfolio. The Strength of Trend Index was designed by Lexington for just this purpose. It effectively measures the cumulative directional price moves from each individual market across the entire Keystone portfolio during each corresponding period.
The graph above shows the dramatic differences in price movement in the Crude Oil market. While the 2003 calendar year (red) offered very little opportunity to make money, the 2008 calendar year (green) offered substantial opportunities to make money by experiencing much large directional price moves.
The Crude Oil graph above contains a Strength of Trend (SoT) indicator at the bottom of the chart. The SoT is experiencing a meaningful uptrend when the indicator turns green, while the red areas indicate a significant down trend. The SoT readings within the yellow band indicate a non-trending market environment with little directional price movement.
The Strength of Trend Index represents the cumulative measures from all of the markets contained within the Keystone portfolio. The SoT Index only recognizes the green and red values, which indicate meaningful directional price movement from each individual market. SoT values within the yellow band in the range between -5 and +5 are ignored because they are not considered meaningful movements. Then, all meaningful values (negative and positive) are converted to absolute values before they are added to the cumulative SoT Index reading. It is important to remember that the Strength of Trend Index measures the directional price movement across the entire portfolio, regardless of whether price moves are up or down.
In the graph above, SoT readings below 100 represent difficult markets with few directional price trends. Extreme SoT readings below 50 represent the most challenging trendless market conditions for the markets Lexington trades. SoT values above 100, on the other hand, generally represent more attractive market conditions where directional price moves provide better profit opportunities. SoT values above 150, or even 200 represent great trending conditions which often translate to very strong profits for the Keystone trading program. Simply put, the higher the SoT reading, the more attractive the market environment is for generating profits and lower SoT readings, especially values below 100, are indicative of more difficult market environments. The 30 year average value of the Strength of Trend is 130, which represents a profitable market climate for the Keystone trading program.
In order to validate the assumption that higher Strength of Trend values equate to higher profits for commodity trading advisors, it is necessary to compare the returns of a managed futures industry index with corresponding Strength of Trend values. In the following graph, the performance for International Traders Research Systematic Index during various SoT ranges is shown.
Average International Traders Research Systematic Index Return for each SoT Price Range
This graph above shows that there is strong correlation between the Strength of Trend values and the ITR Systematic Index returns. This substantiates the idea that the Strength of Trend is a good indicator of profit opportunity for the managed futures industry. Similar to the indexed data shown above, there is also a strong relationship between the returns of the Lexington Keystone trading program and the Strength of Trend.
Another interesting aspect of the relationship between the Strength of Trend and directional price moves is how often certain SoT readings occur. The graph below displays a histogram showing the frequency of occurrence for readings within each SoT range.
Strength of Trend has historically registered values above 100 about 77% of the time, which is usually an attractive environment in which to generate profits, although there is no guarantee of this. It is also encouraging to note that less attractive SoT readings below 100 have historically occurred less than 23% of the time. Furthermore, extremely low SoT readings (below 50) have only occurred less than 1% of the time.
The Strength of Trend is a powerful indicator that can indicate when the market environment is attractive and profits should be expected, and also when the markets are difficult and performance is likely to struggle. The Strength of Trend can effectively provide a context in which to evaluate the performance of a manager within the manager futures industry.
Past performance is not necessarily indicative of future results.
by Mark Helweg and Drew Day
Lexington Asset Management
Clifton House, 75 Fort Street
PO Box 1390, Grand Cayman
KY1-1108
Email: info@ LexingtonAM.com
Web Site: LexingtonAM.com
Phone: 239.273.0142
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