Didn't Buy Warpaint? Why Clear Uptrends Are The Best Uptrends And 20 Stocks To Consider Now

30th May by Edward Croft

92 comments 8975 reads

Ever been in a situation where you’ve loved a stock, but waited and waited for the correction that never came? I’ve been watching Warpaint London (LON:W7L) for a long time as it has many of the traits of multibaggers, but I couldn’t bring myself to buy as the price trend never corrected. I should have known better!

It turns out that shares that stocks that have the clearest price trends have the strongest momentum effects. A recent paper titled Trended Momentum delves into this idea in depth.

The authors demonstrate that shares with distinct price trends more than double the returns to a standard momentum strategy. This has pretty profound implications both for stock pickers and systematic investors who wish to improve their investment results.

More than this, I’ve found that separating the 80+ StockRank universe at Stockopedia.com into a high Trend Clarity set enhances the returns of a 20 stock UK portfolio to more than 14.8% annualised since 2013. Let’s dive in.

What is trend clarity?

The authors of the study theorised that clear and distinct trends are more favoured by investors. They devised an online experiment involving 128 participants who were given charts to assess and rank for trend clarity. They were asked to evaluate the trends of charts from “no trend” to “very clear”.

If you remember statistics classes from school then you’ll have a fair memory of drawing lines of best fit across scatter plots. This is called Linear Regression, and is used extensively across many domains. As you can see below Price Path A (left) has a much better line of best fit than Price Path B (right). It has more trend clarity.

There’s a number, called the R-Squared (or R2) which defines how accurately the scatter can be defined by a line of best fit. A has an R2 above 0.8, B only 0.07. This allows a numerical calculation of the trend clarity. The authors found that using the R2 is a great proxy for finding the same kinds of charts that the survey respondents identified intuitively as having clear trends.

This is a simple approach, and can be replicated in any spreadsheet application - Google Sheets or Excel.

How useful is trend clarity?

The authors separated all the stocks in the market into five buckets…

Unlock with Email

Unlock with Google

Already have an account?
Login here

Alphaflight

4th Jun

Serabi Gold (LON:SRB) looks like a call option on the gold price to me only without the time decay component.

andrewdb

Have you considered looking at "downtrend clarity"

I would expect the indicator is symmetrical and would give insights.

One of my consistent bad habits is buying while a stock is still in a downtrend and not selling when a stock enters a downtrend.

Also, stock price movements on a day to day basis are pretty closely correlated to the relevant stock index. Wouldnt you want to look for a clear trend of outperformance/ underperformance of the index.

Darei

Hi Ed

Would appreciate your thoughts on BAKK

In Jan Paul and Graham gave this co Amber/Red, quite rightly. But now it has a stock rank of 99 and the share price a great momentum! Can you give any explanation

Ps should I be asking Paul/ Graham

Cheers

Edward Croft

Darei - re. Bakkavor - definitely don't ask me. I do some stock picking, but I'm a statistics guy at heart these days!

99 StockRank - my statistical view would be - it's a high quality, high momentum stock. Looks a bit over-extended right now technically, but many stocks in the UK market are getting re-rated.

I haven't, but I would imagine this is exactly the same but in reverse. All the biases we have against buying uptrends, we have against selling downtrends. So smooth downtrends keep people in far longer than they'd like - the momentum will likely persist.

"I have improved my process to take account of this idea. I really like it when I can introduce improvements which are based on academic research!"

Absolutely - glad to hear it's useful. That's really my point of view on the academic stuff - if we can pull useful heuristics (rules of thumb) from academia, it helps with everyone's stock selection. Whether as stock pickers, or as more mechanical investors.

I think improving one's judgement is about developing good rules of thumb!

Rusty2 - yes there are a lot of well advanced shares in the list.

I wouldn't be surprised if I get called out by someone for this list underperforming in 6 months - but the odds are favourable if the UK market continues its recovery.

It's the principles I'm mostly trying to convey. It's not a conviction buy list! DYOR / no recommendations.

Barbara

5th Jun

Could we have a monthly post on a separate thread on stocks meeting the criteria to keep this in focus and current? Ken’s monthly update on investment trusts is always a must read and feel this topic deserves the same.

rmillaree

Hmmm what is the causing factor here for these shares to be moving upwards ???- we say for this specific group they have a higher than average prior history of beating expectations - ok no no shit Sherlock - if we take a group of shares doing better than previously expected - where would we expect the price to trend in the next 12 months up or down?

So what is the cause of these shares doing well ? is it the clear trend or the fact we have picked a sample group that are known to have performed well compared to prior expectations.

By picking a biased sample the results will obviously look good. Compared to the whole where there are more companies that have had poor updates. To get fair comparison here I would like to compare results against sample of stocks that have similarly beaten expectations but ignoring the trend - and see which ones perform better on future basis.

It is very interesting that these stocks continue to beat expectations into the future - that seems like genuine good news - the reasons though seem common sense related - if stocks have decent short term history of beating expectations it shouldn’t massively be a surprise that this subset of companies hitting a sweet spot should hopefully be expected to perhaps continue that good form.

In summary are these strong trends not the obvious result of having started with subset of shares that have known to have done better than previously expected. Note by comparing against similar set of beating companies “trend ignored in reference period ” it will be interesting to see if the results for that subset is beaten.

Note I am not doubting that this could be a good screen - there will be many companies that perhaps beat due to random reasons - that don’t really then have great plan going forward - so it could be that the proof of the pudding has been delivered by shares with rise in price in that the test of the market has also been met that they have satisfied the market in respect of past and future.

Barbara - I can't commit to it at the moment, but trend clarity is a factor that quite a few of us here are keen to explore more.

rmillaree - not sure why you'd say it's a biased sample. It's just a set of stocks in an uptrend with a good fit regression line. It's all historic information, available at the time of portfolio construction - why is that biased?

Do read/scan the paper. There's a lot in there, especially on earnings surprises (SUE). High momentum, clear trend stocks do have higher historic earnings surprises.

I wouldn't be surprised though if the trend clarity factor was a better predictor of future returns than the more salient earnings surprise factor. But that needs research.

DWit199

Is the good regression fit simply low recent volatility?

I wouldnt want to presume either way - but i would be very interested for comparisons to be run between this method and a method based on "earnings surprise alone" - as this sample clealry has bias in that direction ref consituent parts - imho its possible that that could be the reason the data beats the market on average as clearly there is less of the crapola companies dissapointing being included - one would have to run the comparison to find out though - that would be interesting test from my viewpoint. One other test would be trend plus excluding any companies failing to meet expectations as perhaps that could trump both results.

rmillaree - not sure why you'd say it's a biased sample.

if you run the test on companies beating earnings alone (ignoring trend) and that came up with the same results that would suggest to me the reason for the good performance may be the earnings beat as much if not more than the trend.

with any sample of data being used you have to be careful not to pick a biased susbset to get fair results or find out what is causing the outperformance imho. its so easy done to choose subset of data that can have other reasons for results than what you may be looking at as your main indicator. Whether that matters ot not is another matter - i dont knock that this method appears to work - just trying to understand what is the reason for the outperformance - to some of most it may not matter as to why it is so.

WarrantStar

Hi rmillaree. Like you, I would be interested in the reason for the outperformance. I did consider trying to find out what the news was that started the price rising, and putting this as a step in my process. But in the end I ruled it out because of the work involved and my lack of clarity as to how I would use the information. In the end I settled to just make use of the fact that shares with a higher degree of clarity of the 6m share price uptrend are likely to do better than those with no, or an unclear uptrend.

abtan

Hi Ed
I'm not sure if this is the place for it, but I'd certainly be interested in seeing research on a Value Strategies over longer time periods, say 2-3 years.

I don't generally follow a Momentum Strategy as I personally try to position my portfolio between:

Long Term Compounders, that I never need to think about, and;
Deep Value unloved companies, where I expect to make material gains over 1-3 years.

Obviously with the latter I'm very dependent on when that value is realised, hence the longer time frame required.

I have made my largest gains from Value, hence my interest here, and I imagine that if I looked at those holdings on a 6-12 month timeframe they might look like failed investments compared with something like the NAPS Portfolio.

But would that still be the case over say 2/3/4 years?

It would certainly be interesting to see some insight behind this.

Thanks

littledavesab

Thats very interesting, thanks Rusty

Paul Walton

These are the stocks at the moment with the cleanest trends according to Andreas Clenow's method if anyone's interested. The only stipulation ive made is not to include any Sucker stocks

Bluesky Ventura

Well-defined rules for why you buy would avoid missing out and momentum alone would make it difficult for me to justify an investment.

Looking back as to why I invested It was all related to value investing and being able to buy it at NAV for an average buy price of 36p. (see graph below).

My Valuation from March 2020 data.

$W7L has become my largest position due to stellar performance over the past 4 years. You have to give credit to management's growing experience and skill for improving business and potential valuations. My rules mean I have been a seller at predetermined prices, as the company keeps exceeding expectations and dominates my portfolio.

Valuation from June 2024.

Today I can still see the company being able to improve the business and resulting valuation. (see above graph). I wish all current and future holders well.

As always DYOR

BSV

Daniel Rudd

9th Jun

When to sell - 6 Month R2 < 1 year R2

ed_miller

17th Jun

Yeah, personally I think the high volatility of small caps explains it - not generally going to get an R2 close to 1.

I wonder whether you could correlate price performance to beta value rather than to R2 trend clarity? Wouldn't be surprised if the correlation to beta was too noisy though.

Didn't buy Warpaint? Why clear uptrends are the best uptrends and 20 stocks to consider now

What is trend clarity?

How useful is trend clarity?

Unlock the rest of this article with a 14 day trial

About the Author

Edward Croft

92 comments

Unlock the metrics for all these stocks and more...

Unlock the metrics for all these stocks and more...