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Trend Following: Profitable Reality or an Illusion doomed to

Posted: Tue Apr 02, 2013 7:45 am
by AFJ Garner
My recent work has been designed to penetrate the heart of this topic: I have discussed and back tested random entries at some length, I have queried the use of back testing and I have tried to explain why, over the past 40 years, trend following seems to have become increasingly difficult.

One of my contacts (a highly intelligent contact at that) holds that trend following is a dangerous illusion:

A “single threadedâ€

Posted: Tue Apr 02, 2013 12:55 pm
by BuyHigh SellLow
I'm borrowing a quote from my favorite CTA...

"If not trend following, then what? Are you going to add to losing trades and fight price trends? You have no choice."

Posted: Tue Apr 02, 2013 1:09 pm
by BuyHigh SellLow
BuyHigh SellLow wrote:I'm borrowing a quote from my favorite CTA...

"If not trend following, then what? Are you going to add to losing trades and fight price trends? You have no choice."

Also, here is something I wrote earlier in an email to a TF friend of mine:

I completely agree that the "liquidity for hedgers" argument doesn't really cut it. I'm willing to say that "speculators get compensated for taking the price risk from hedgers." But, who says that speculator equals trend follower? Instead of saying trend following earns a fee for providing liquidity to hedgers, I like to think of that video from the NYTimes that talks about the need to "earn your returns by feeling uncomfortable." Trend following is just a different type of discomfort. The risk in owning stocks is that stocks will basically go down; the risk in being a trend follower is that markets will not trend to a meaningful enough extent for a particular set of trend following parameters to be profitable. So, we take uncomfortable trades, we have more losing trades than winning trades, and we spend the majority of our investment lives in some degree of drawdown. But, even that isn't a complete explanation; there are plenty of "risks" I could take where I shouldn't have an expectation of making money. Example: using the Super Bowl winner as a bullish/bearish signal for the S&P is worthless.

I think long-equity guys have a fair bit of explaining to do themselves. If they're sitting there talking about buy-and-hold for U.S. equities because of the great returns it has had for the past one hundred years, then they're selling the results of what has essentially been ONE trade in ONE market. How can they call that a "strategy" and be putting TF on the defensive?

"Why should trend following work?" I think people are often asking where the "economic basis" is for trend following. To a hammer, everything in the world is a nail; to an investor who uses fundamental analysis, everything must have an economic basis. But that assumes that we, as emotional and irrational humans, have the ability find an economic basis wherever and however it exists. Who says we do? My version of trend following's economic basis is that market prices have a delayed reaction to fundamentals, resulting in trends on the way to the "correct" price. Further, markets often overreact due to herding and push prices beyond the "correct" price, meaning the trend gets extended. But, people can find a decent enough "logical" explanation for pretty much anything after the fact.

At the end of the day, we're empiricists. Some of us [TF, many quants, some value guys] just treat the process more rigorously than others. What if markets had been mean-reverting instead of trending during the last 100 years? I would bet that many of the same people who are "trend followers" now would have been "mean reverters" in this imaginary, alternate universe.

But, we live in a trend following universe. Period. For any doubters who questioned the past three decades of TF results, what possible excuse can the doubters have now that AQR released TF data going back SEVEN DECADES before Richard Dennis? The AQR paper, in my view, is the ultimate out-of-sample test validating the power of trend following.

Finally, two quotes I thought about while writing this:

1) "Ok, so you've found something that works. Don't spend the rest of your life trying to figure out exactly how and WHY it works. Believe in it; trade with it." [paraphrased from Jim Simons...I read this years ago but can't find the exact quote]

2) "Because I believe that all criteria for investing (that is, good betting strategies) should have a logic that isn't time-specific, I believe that the alpha generators that make up the ultimate alpha generator should be timeless and universal. By that I mean that they should have worked over very long time horizons and in all countries' markets." Ray Dalio

Posted: Tue Apr 02, 2013 4:12 pm
by sluggo
But of course you know how to design, and test, and trade, "multi-threaded" trading strategies if you so choose. The capability has been built into Trading Blox literally from day one, when we had the not_yet_programmable predecessor software release called Veritrader.

These "multi-threaded" trading strategies can sometimes require huge amounts of capital to trade, if each "thread" requires a large capital allocation even at the smallest permitted size. Fortunately this difficulty is easily surmounted, by forming a trading Fund which pools the assets of numerous investors into a single account. Now you do indeed have huge amounts of capital to trade, so "multi-threaded" strategies are quite feasible, even for very large numerical values of "multi".

And, of course, there is nothing to prevent you from combining two well-known ideas:
  1. using "multi-threaded" trading strategies;
  2. introducing a random component into trade timing / trade direction / position sizing

Posted: Tue Apr 02, 2013 6:35 pm
by Toosday
I can understand always questioning everything when it comes to the market. The one thing I have proven to myself is that the price distribution tails are fatter than would be implied by a random distribution. I try to focus on that. If you cut losses and ride winners, I think that this allows for profitable trading.

Now whether trend following appropriately cuts your losses and rides your winners . . .that is a different discussion.

Posted: Wed Apr 03, 2013 9:14 am
by stamo
IMHO, Bill Gross's latest Investment Outlook is relevant --
[quote]All of us, even the old guys like Buffett, Soros, Fuss, yeah – me too, have cut our teeth during perhaps a most advantageous period of time, the most attractive epoch, that an investor could experience. Since the early 1970s when the dollar was released from gold and credit began its incredible, liquefying, total return journey to the present day, an investor that took marginal risk, levered it wisely and was conveniently sheltered from periodic bouts of deleveraging or asset withdrawals could, and in some cases, was rewarded with the crown of “greatness.â€

Posted: Wed Apr 03, 2013 9:50 am
by AFJ Garner
Superb article; philosophically in line with my own far less august reasoning.

Posted: Sat Apr 06, 2013 3:54 am
by AFJ Garner
I have no doubt whatsoever that there are "trends" - periods of time when prices go from A to B without too much retracement or noise. I have also no doubt that trends are seen in every timeframe - that such patterns are fractal. It is true that you can not see a trend until it is over - as the market trades, you have no idea whether the price will go from A to B relatively smoothly in a given timeframe or to any other point, smoothly or otherwise.

I don’t care “whyâ€

Posted: Sat Apr 06, 2013 1:13 pm
by Chris67
Personally I think its glaringly obvious what has changed - AND i seem to recall Bill Gross and George Soros saying the same thing in the last 3 days ?

Market intervention to hold markets at superficial levels where they should not be where supply and demand [ x-government/ central banks] is now not what causes price moves and where teh only hope for the Worlds financial system is a continuing ramping and pumping to hold teh status quo

That really is all that changed
It happened on a minor scale after LTCM and after 2008 its teh only game in town because I honest believe if intervention steps aside teh Dow will print ZERO and that will be the easiest trend you will ever encounter - unfortunatley its now too late - bit like an addict - the CB's will need more and more of their crack to get the same job done

Where we are at is truly frightening and I would urge people to consider where they hold their money and what they define as money - NOT if their system works as well as it used to !

Posted: Sun Apr 07, 2013 3:08 am
by AFJ Garner
Many thanks to all for your thoughts and contributions. As I have said repeatedly, I have no doubt whatsoever that there are trends and that such trends are caused by supply and demand in the economy and human behaviour. I do not believe in the EMH. I do not believe that the markets are a markov chain. I believe that there is autocorrelation in markets for periods of time as participants adjust to ongoing economic reality and herd instinct.

What I do believe however is that these trends have become increasingly difficult to follow and profit from using mechanical systems in the recent past. Analysis of autocorrelation, of the profitability of trend following systems, of the “efficiencyâ€

Posted: Mon Apr 08, 2013 11:56 am
by BuyHigh SellLow
Maybe Richard Dennis said it best:
"When in doubt, do half."

Posted: Thu Aug 01, 2013 3:23 pm
by liaojing
BuyHigh SellLow wrote:I'm borrowing a quote from my favorite CTA...

"If not trend following, then what? Are you going to add to losing trades and fight price trends? You have no choice."
From what I observe, trend following totally depend on luck/epoch, we have zero control on when there will be (lots of) big trend, when it is trendless.
So in trend following, we can't control our fate, our fate totally depends on that epoch. We are unable to make big money in a trendless year.
In contrast, stock investment/fundamental analysis maybe a better option, or at least a complement to trend following. If you are really sure about the fundamental about a stock/company, even if you experience 2008 crash, if that company's fundamental is intact, hold it, its price will create new high eventually.
My opinion is trend following is a good complement to stock investment, but if trend following is our only investment, we may not be able to control our fate...

Posted: Fri Aug 02, 2013 10:20 am
by AFJ Garner
Agreed on lack of ability to control, fate. Either there exist enough strong, long trends; or not. I talked to the head honcho at Transtrend a couple of years ago about an investment I had there for a FoF: he said exactly the same thing.

Posted: Wed Sep 25, 2013 12:36 pm
by chimera123
From what I observe, trend following totally depend on luck/epoch, we have zero control on when there will be (lots of) big trend, when it is trendless.
So in trend following, we can't control our fate, our fate totally depends on that epoch. We are unable to make big money in a trendless year
Doesn´t this apply to all strategies? Of course, CTA´s doesn´t tell this their investors but at the end you need luck on every investment you do.

If trendfollowing is not the right choice or even a zero sum game, what else is left? Arbitrage,Fundamental,Pattern, Seasonal or counter trend stratgegies? Does this do any better? Even when combined,I doubt it.

Let the markets sort them out, be patient and you will be rewarded. I don´t believe those stories that markets have now changed forever and trendfollowing will never become profitable anymore, good times will come back we just don´t know by when.


Posted: Wed Sep 25, 2013 3:57 pm
by rdh2f
Very good discussion. I think after 5yrs of losing money the only "systematic" traders that have been consistently profitable are those that "cheat", those HFT who get info earlier or execute faster. Not traders but thieves.

Moreover, it's not just trend following that has struggled. For example, Cantab and Winton are multi-strategy and have performed extremely poorly. Abraham on a smaller scale as well. Winton is moving into single equity just to have a long equity bias hedge.

Markets move in cycles and 5yrs does not invalidate 50yrs+ of profitability. However, I agree things have changed. Speed, crowding and post-2008 central bank interventions have distorted markets beyond what we saw in the previous 50yrs.

So where does that leave us? I have focused recently on the paradoxical counter-trend nature of the trend following equity curve. If one can counter trade their trend following equity curve to capture most of the parabolic moves and "take off" some during the inevitable drawdowns, I believe the concept deserves further exploration.

Posted: Wed Sep 25, 2013 4:20 pm
by marriot
Currencies are the worst performing from Jan 2011.
What you see is a Long /Short Triple moving Average trading only Currency Futures.

Posted: Wed Sep 25, 2013 6:51 pm
by Roger Rines
I haven't subscribed to the idea that Trend Following isn't a viable method any longer because I often see performance results that indicate other wise.

This Linear Chart w/ Draw-down% indicates the opportunity isn't behind us, at least not yet. However, the flat period we've been going through for the last 2-years is pointing to what appears to be the most difficult time in the last 32-years.

If this persist for too long it will indicate something needs to change, what that is I don't know, but for now treading water seems better than drowning.

Posted: Thu Sep 26, 2013 11:51 am
by Outlaw
Attain recently weighed in on this as well: ... alysis/522

Posted: Thu Sep 26, 2013 4:02 pm
by rdh2f
Trend following may work for 100 years but the issue is that most people only have 3 or 5yrs (at most) of capital to give it a run. Those individual traders that prosper or fail exploiting a TF system is a function of luck (or bad luck) in my view.

Posted: Thu Sep 26, 2013 4:14 pm
by AFJ Garner
Which is why people should keep their allocation low, their leverage low or both. Then they will survive till the good times roll.....