Classical Trend Following versus Other Applications
Trend following is an investment strategy that is usually associated with diversified, managed futures strategies that CTA’s and now, some mutual funds utilize. You pick a wide selection of diversified markets (equities, bonds, commodities, currencies). These markets have different characteristics in relation to each other: non correlated, correlated and uncorrelated markets. You apply entry and exit strategies and risk management to limit total risk and sector risk and run the system with total conviction, taking every trade good or bad. At the end of a substantial time period (5-10 years), you should expect to come out on top.
This “classical” method of trend following can require a lot of capital. Just do the math on 40-60 different futures markets and only one contract per each market. It’s a lot. Although you could give up a lot of diversification and run a more simplistic model with less markets and thus, less capital.
However, some are taking the same types of trend following models and applying it to stocks. Why is this a good idea? Because over time, stocks are expected to rise ( just read, Triumph of the Optimists: 101 Years of Global Investment Returns).
You make a lot of money in a bull market following the trend and then give back 25 % or so in a bear market if you can manage risk and size down positions when volatility increases (as an example of one type of model on equities that I have in mind).
Classical Trend Following vs. Trend Following applied to stocks.
Both work and both have positive Expected Value over time. It might be easier for some investors to be comfortable with being long stocks instead of short pork bellies or long lean cattle. In this way, the classical trend following methods applied to stocks can make a lot of sense to those newer to trend following.
Classical Trend Following is generally non correlated to the stock market over a long enough time. So, its great when 2008 comes around and during that time period, trend following strategies actually made a lot of money, while stocks lost money. This saved your overall portfolio in a lot of cases. Obviously, Trend following applied to stocks, is correlated to the stock market.
Just being in the stock market for the past 15 years hasn’t been that great. 2 separate ~50 % drawdowns kicked some buy and holders in the face while generally trend following in the diversified managed futures space had less substantial drawdowns.
If you are interested in Trend Following I would recommend Trend Following by Michael Covel and Following the Trend by Andreas Clenow. Both are excellent books and there are even more great books on this still under invested strategy.
For those that are interested, right now is a great time to consider investing in Diversified Managed Futures strategies that use trend following methods. Why? Because they generally are in a significant drawdowns across the board from all time highs. It has been a tough road for Trend Following since the windfall- esque profits of 2008 (40% + for some funds). Buying these drawdowns has been a great strategy historically. If you need any direction on who to look at, feel free to send me an email and I can share my list with you on who I look at in the space.Scridb filter