19 Jan

The Dow Jones Industrials Bullish Crossover Portfolio

19 January 2012 |
Written by Skot Kortje, Stock Trends Analyst
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A trend-following trading system can be both simple and profitable. The Dow Jones Industrials Bullish Crossover Portfolio is just one example of how long-term investors can use the Stock Trends indicators.

The Stock Trends Bullish Crossover () and Bearish Crossover () are key signals that a long-term price trend has changed, but for many investors these moving average indicators appear to be too lagging current market prices to generate trading success. Indeed, the premise of trend analysis is that moving average market timing buy signals forgo early price movement in order to definitively categorize a new price trend, and that trade exit markers provided by moving averages are well behind price action trade exits – a dual handicap that some investors would find intolerable.

However, the best way to challenge these misgivings is to produce a trading record that substantiates an ongoing trading plan employing moving average crossovers as both buy and sell signals. Long-term investment returns achieved when using the Stock Trends Bullish and Bearish Crossovers indicators ( and ) will surprise sceptics.

The most well-known subset of the North American stock market is the Dow Jones Industrials. The 30 stocks that currently comprise this benchmark index are large capitalization, blue chip companies – many multinational – that cover a broader spectrum of the economy than the ‘industrials’ misnomer suggests. Although large cap stocks have a tendency toward lower price momentum than small- and mid-cap stocks, they do exhibit strong trend tendencies and lower volatility relative to the broader market. They are also supported by institutional demand dictated by their status as components of this important index. It is no wonder they are typically held by conservative investors wired into the changing fundamentals affecting the valuations of these companies.

In contrast, Stock Trends mechanical trading strategies dispense with the storylines of fundamental analysis and engage in a very simple but methodical application of trend line market timing. The Dow Jones Industrials Bullish Crossover Portfolio shows how simple trend-following trading strategy can be – and how the long-term returns the strategy generates are better than the market benchmark.

The Dow Jones Industrials Bullish Crossover Portfolio trading strategy:
BUY a component stock of the Dow Jones Industrials index when: tagged with a “Bullish Crossover” indicator
SELL a stock when: tagged with a “Bearish Crossover” indicator

* This strategy has been applied on the stock history of the 30 current (December 31, 2011) members of the Dow Jones Industrial Index. It does not replicate this strategy on the historical components of the index. Changes to the index in the last decade, for example, brought in new membership for stocks such as Cisco Systems, Bank of America, The Travelers Cos., Kraft Foods Inc., Chevron, Pfizer Inc., and Verizon Communications Inc. See Historical Components of the Dow Jones Industrial Index. The portfolio will make adjustments going forward for changes in the constituents of the Dow Jones Industrials index.

Current components of the Dow Jones Industrials Index:

	Stock	Symbol		Stock	Symbol
1	ALCOA INC	AA	16	JP MORGAN CHASE CO	JPM
2	AMERICAN EXPRESS INC	AXP	17	KRAFT FOODS INC	KFT
3	BOEING CO	BA	18	COCA-COLA CO THE	KO
4	BANK OF AMERICA	BAC	19	MCDONALDS CORP	MCD
5	CATERPILLAR INC	CAT	20	3M COMPANY	MMM
6	CISCO SYSTEMS	CSCO	21	MERCK CO INC	MRK
7	CHEVRON CORP	CVX	22	MICROSOFT CORP	MSFT
8	DU PONT E I DE NEMOURS	DD	23	PFIZER INC	PFE
9	WALT DISNEY CO	DIS	24	PROCTER GAMBLE CO	PG
10	GENERAL ELECTRIC CO	GE	25	AT&T INC.	T
11	HOME DEPOT INC	HD	26	TRAVELERS CO	TRV
12	HEWLETT PACKARD CO	HPQ	27	UNITED TECHNOLOGIES	UTX
13	INTL BUSINESS MACHINES	IBM	28	VERIZON COMMUNICATIONS	VZ
14	INTEL CORP	INTC	29	WAL-MART STORES INC	WMT
15	JOHNSON & JOHNSON	JNJ	30	EXXON MOBIL CORP	XOM

An example of this trading strategy at work

The following Stock Trends chart shows the changing trend indicators over the 5-year period from early 2007 for Caterpillar Inc. (CAT-N). It depicts three Stock Trends Bullish trend categories - all introduced by a Bullish Crossover indicator ( ) and closed by a Bearish Crossover indicator ( ). These bullish trend periods are illustrated by the green areas underneath the bar graph of the stock's weekly price. In this time period, the first Bullish trend buy for Caterpillar's stock (CAT) was on April 13, 2007 at $66.79. The stock was sold at its Bearish Crossover on December 7, 2007 at $74.20 for a trade gain of 8.9% (all returns are net of the trading system's defined transaction costs). The second position taken in CAT was at its Bullish Crossover on April 25, 2008 at $82.25. This holding was sold with the Bearish Crossover indicator of August 22, 2008 at $70.27 for a trade loss of 16.3% - quite indicative of the difficult market conditions during the unfolding financial crisis of 2008. The final bullish trend of the illustrated period is much more rewarding. The stock's Bullish Crossover on July 17, 2009 signaled another buy at $33.99 and ushered in a strong uptrend that peaked at $116.55, eventually slipping back to a bearish trend 109 weeks later. The Bearish Crossover sell signal on August 19, 2011 at $79.97 earned the position a handsome 131% return.

The money management rules for the portfolio are as follows:

Exposure on each position is limited to $10,000. Although the average number of positions held since 1981 is 17, the strategy could potentially require holdings of all 30 stocks at one time. Conversely, the system will not hold many stocks at all in bearish markets. During bear markets of this trading record, the portfolio holdings fell to an average of 5 or 6, while the most active year (1997) the average number of stock held by the portfolio was 26.

Transaction costs are factored into the cost of purchases and the net proceeds of sales at 1% in and 1% out, or 2% commission on a round trip.

Applying this very simple trading system on the Stock Trends 31-year historical data of current components of the Dow Jones Industrials generates the following results:

Complete trading history

The three decade trading record has produced positive relative returns. The annualized return on average capital invested is 15.9%, better than the 7.4% compound annual growth rate of the benchmark S&P 500 index over the same period. However, recent relative performance of this trading system reveals the difficult period the system has encountered over the past decade.

As the table below shows, the 2000s have not been a great time for trending stocks. Compared to its impressive returns of the 1990s, the DJ Industrials Bullish Crossover Portfolio trading strategy performance of late has not been strong. But compared to the negative returns of the overall stock market - the S&P 500 index was down 24% in the decade ended December 31, 2009, with a compound annual growth rate of -2.7% - the portfolio's -2.6% annualized return over the dismal first decade of the millennium rates as satisfactory.

The ten-year return prior to 2000, though, showed much more promise for this trend-following trading system. The DJ Bullish Crossover Portfolio enjoyed an annualized return on average invested capital of 32.3%. Comparatively, the S&P 500 index had a compound annual growth rate of 15.3% during the same decade.

DJ Industrials Bullish Crossover Portfolio strategy Performance - 1981 to 2011:

			% Returns
Year	Average Invested Capital	Net Gain/(Loss)	ST Portfolio*	S&P 500 Index	Difference
Since inception 31.1 years Jan 1/1981 to Dec 31/ 2011	$ 171,916	$ 844,890	+15.9% p.a.	+7.4% p.a.	+8.5% p.a.
2011	191,509	-16,287	-8.5	0.0	-8.5
2010	205,283	11,673	5.7	12.8	-7.1
2009	134,340	59,490	45.4	29.1	16.3
2008	67,547	-40,835	-59.3	-41.0	-18.3
2007	230,189	28,957	12.5	4.2	8.3
2006	203,585	23,574	11.7	13.6	-1.9
2005	156,038	-11,506	-7.4	3.0	-10.4
2004	199,811	3,099	1.6	10.4	-8.8
2003	185,283	41,862	22.7	25.2	-2.5
2002	95,660	-34,992	-36.3	-24.6	-11.7
2001	107,925	-36,875	-34.1	-12.1	-22.0
2000	129,245	-75,064	-58.1	-10.1	-48.0
1999	216,226	140,505	64.5	19.5	45.0
1998	195,283	115,399	59.1	31.0	28.1
1997	257,925	88,549	34.2	23.7	10.5
1996	239,245	103,473	43.4	22.9	20.5
1995	243,019	107,789	44.3	34.1	10.2
1994	159,057	-147	-0.1	-1.5	1.4
1993	166,981	5,114	3.1	7.1	-4.0
1992	183,396	9,184	5.0	8.2	-3.2
1991	186,415	71,615	38.2	23.7	14.5
1990	153,019	-2,212	-1.4	-7.0	5.6
1989	238,868	101,415	42.4	27.3	15.1
1988	120,755	-3,917	-3.3	12.4	-15.7
1987	200,377	-5,475	-2.7	2.1	-4.8
1986	199,245	62,940	31.4	17.8	13.6
1985	180,755	44,764	24.9	26.1	-1.2
1984	102,264	-29,285	-29.0	0.8	-29.8
1983	191,132	47,492	24.7	17.3	7.4
1982	133,962	48,723	36.8	14.8	22.0
1981	53,585	-4,535	-8.5	-10.1	1.6

* ST portfolio annual returns are based on average invested capital for the year.

Tough times in the new millennium

	% Returns
Year	1-year	2-year	3-year	5-year	10-year
Dec 31, 2011	-8.5	-1.2	9.6	4.9	3.7
Dec 31, 2009	40.8	12.8	10.4	7.8	-2.6
Dec 31, 1999	64.5	57.7	51.7	48.1	32.3

* ST portfolio annual returns are based on average invested capital for the year.

Returns on invested capital are a good measure of long-term performance of a trading strategy, but the statistics revealed by the trade history are a good metric of how those results were achieved. The distribution of returns of the 620 positions closed before December 31, 2011 shows that the majority of trades returned between -20% and +10%. Profitable trades were 42% of all positions - below 50%, but typical of many successful market timing trading systems. The trading system's Profit Factor of 3.1, though, reveals the strength of the trading strategy. It measures the the relative $ gains of winning trades versus the relative $ losses of losing trades. Average gains per winning position are over three times higher than the average losses per losing trades. This characteristic allows the system to generate positive returns over the long-term, even though most trades are losing trades. Because expectations of high probablity trading (expecting that a trade signal will ALWAYS be right) should always be tempered by actual results, active traders must always seek to achieve a trading record with a relatively high Profit Factor. This trading strategy scores well on that measure.

Trading Statistics
Total # of (completed) positions taken:	620
# of winning positions (winning %):	359 (42.1%)
Average gain(%) per winning position:	48%
Average loss(%) per losing position:	11%
Profit factor**:	3.1
Maximum gain(%) on a position:	570%
Maximum loss(%):	-45%
Annualized return on average invested capital:	15.8%
Average invested capital:	$171,916
Average # of positions held:	17
Average # of weeks invested in each position:	44
* all trading stats compiled at December 31, 2011 on closed positions **Profit Factor = (% of winning trades X average $ gains on winning trades) / ABSOLUTE VALUE[(% of losing trades X average $ losses on losing trades)]

The current Dow Jones Industrials Bullish Crossover Portfolio report is published weekly. It shows current holdings, as well as current buy and sell transactions. Investors can follow the report to emulate the performance of the portfolio or use this model portfolio to adjust their own holdings in these important blue chip stocks.

Published in Stock Trends