What if Everyone Adopts Trend Following?

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Hey, as the trend following message reaches a greater audience, it makes me curious to hear what your thoughts are on the far fetched question of what would happen to markets if a majority of market participants adopted trend following (how many times do you get this one?)? I believe that’s a virtual impossibility, since among the current minority of trend followers many probably don’t even follow their systems properly. One would also suppose that the underlying supply and demand forces for actual commodities, goods and services would always drive a trend at some point, no matter how many trend followers were waiting for a move. Also, let’s not forget the invisible hand of… governments. I guess since a lot of trading is done by participants who ultimately are end users of the produced units (who knows what proportion that actually is) that makes the “majority as trend followers” an impossibility (and probably a good thing). It would be an interesting thing to model even if the premiss really isn’t possible. Would prices flat-line or trend even more?

Those are all reasons why it will never happen + http://en.wikipedia.org/wiki/Behavioral_economics + human nature loves bubble. Greed and fear aren’t leaving, right?

Unquestionably right. Mine is more of an academic question, as unrealistic as asking, “what if most men and women stopped having sex? ” (except we all know how that would turn out). What if you could have a majority trading only systematically. No fear, no greed. The theoretical result on price movement probably not as easy to predict. Flat-line, or even greater trends? Frankly pointless to try. Interesting to ponder. I clearly have too much time on my hands today. Thankfully, greed and fear are here to stay. Enjoy your weekend!

To clarify: trend following is systematic. You are right though, greed and fear is here to stay. That’s great news for trend followers.

Hey Michael, I have to give you a shout out for Episode 52. You “rocked” it. The hair band tunes were a nice touch. I don’t know how many times I laughed out loud but your delivery and timing was impeccable. The best comedy is always the stuff that resonates and is true. Have a safe and fruitful trip to Asia. I hope you can keep the podcasts going while you’re there!

Later the conversation continues:

Hi Mike, I just finished reading The (Mis)Behavior of Markets, A Fractal View of Financial Turbulence by Mandelbrot & Hudson (2004). Many mathematically inclined folks will have heard of Mandelbrot’s work. This book has Trend Following stamped all over it. I thought I’d share a passage where, to explain what it feels like to live through turbulent (fractal) markets, the authors put it in terms of a parable: “Once upon a time, there was a country called the Land of Ten Thousand Lakes. Its first and largest lake was a veritable sea 1,600 miles wide. The next biggest lake was 919 miles across; the third, 614; and so on down to the last and smallest at one mile across. An esteemed mathematician for the government, the Kingdom of Inference and Probable Value, noticed that the diameters scaled downwards according to a tidy, power-law formula. Now, just beyond this peculiar land lay the Foggy Bottoms, a largely uninhabited country shrouded in dense, confusing mists and fogs through which one could barely see a mile. The Kingdom resolved to chart its neighbor; and so the surveyors and cartographers set out. Soon, they arrived at a lake. The mists barred their sight of the far shore. How broad was it? Before embarking on it, should they provision for a day or a month? Like most people, they worked with what they knew: They assumed this new land was much like their own and that the size of the lakes followed the same distribution. So, as they set off blindly in their boats, they assumed they had at least a mile to go and, on average, five miles. But they rowed and rowed and found no shore. Five miles passed, and they recalculated the odds of how far they had to travel. Again, the probability suggested: five miles to go. So they rowed further – and still no shore in sight. They despaired. Had they embarked upon a sea, without enough provisions for the Journey? Had the spirits of these fogs moved the shore?”

For those who don’t make the connection, the authors clarify:

“An odd story, but one with a familiar ring, perhaps, to a professional stock trader. To bring it down to earth, rewrite the parable and set it at the New York Stock Exchange. For explorers, read investors. For fogs, read the limits of our knowledge. And for the lakes, read the prices of 10,000 different securities. Have you alighted upon a stock the price of which will run and run until your profits are so vast you cannot count them? Or have you found a loser that, just as the price seems to take off, unexpectedly falls short?”

Mike, thanks again for all the great interviews. My trading wouldn’t be where it is today without them and of course without your books which were the catalysts. Congrats on making your first million (listens)! Cheers, Georges