The Trend Barometer measures the percentage of markets with medium to strong trends. Just as a thermometer reading of 32 degrees Fahrenheit equates to freezing, when the Trend Barometer reads a value that is less than 40%, market trendiness begins to get “colder” or weaken. Likewise, when the Trend Barometer gets “hotter”—that is, moves above 45% — the more markets are trending.
There are many ways to define the concept of “trend.” The market trend index is one possible approach, which happens to be a useful explanatory factor for CTA performance. The first step in computing the market trend index is to calculate a signal to noise ratio (SNR) for asset prices over a given lookback period. The SNR is simply the absolute price change over the lookback period divided by the sum of the absolute daily price changes. For a short term trend index, a period of 10 days is used. The medium and long term indices use 40 and 80 days respectively. The closer the price path is to a straight line, the higher the SNR. A perfectly straight line will have an SNR of 1, while a completely flat path will have an SNR of 0. Below are some examples with generated data:
In the second step, the SNR for individual futures is aggregated into an index by taking the relevant average. For example, the equity sector trend index is the average of the SNR for equity futures such as the Dow Jones Industrial Average, S&P 500 E-Mini, Eurex DAX 30 and the FTSE 100. An overall trend index would be the average among all tradable markets.
Because this market trend index is a measure of how “trendy” futures prices are, it tends to be correlated with CTA trend-follower performance over comparable time frames. Below is a plot of the NewEdge CTA index 40 day returns alongside the trend index computed for the same period:
The correlation between these two series is 56% (R2=75%).