Drawdowns are Part of the Game


Hi Michael, I really enjoy listening to your podcasts and learning about trend following. However I am confused by an apparent contradiction that often comes up in these talks. Your guests often make the point that investors who follow a buy and hold strategy must have the fortitude to withstand periodic large drawdowns of 30% – 60% and that trend following does not suffer from this disadvantage. By implication trend following is a superior strategy that offers good returns but without significant drawdowns. This was discussed in your interview with Mike Shell but there have others examples as well. However in other interviews with money managers who use trend following strategies, the point is often made that significant drawdowns are a perfectly normal and expected feature of their strategies and must be accepted as they will be outweighed over time by superior returns. I think you have also made the point that managers who show consistent positive monthly returns should be regarded as suspect as drawdowns are a normal occurrence. These arguments appear contradictory and confusing to me. As I understand it, both strategies suffer from significant drawdowns so it cannot be said that low drawdowns are a specific advantage or benefit of trend following. I can certainly understand that the timing of the drawdowns (e.g. buy and hold in 2008 and trend following in 2011) may be very different but over time surely both will suffer from them. Please can you help me reconcile these apparently contradictory arguments. Many thanks.

Peter Bernstein

No contradiction in my books. Draw downs are a fact of life in the TF world. The question for you: After reading my books and taking into account all issues do you see buy and hold and TF as equal strategies?

You might like my 2017 epic release: Trend Following: How to Make a Fortune in Bull, Bear and Black Swan Markets (Fifth Edition). Revised and extended with twice as much content. Out April 24th 2017.

3 thoughts on “Drawdowns are Part of the Game

  1. Peter:

    In addition to the severity of the drawdown, one has to consider the duration of a drawdown. Does a particular strategy recover in months or years? This is where ratios such as the ulcer index come into play when comparing strategies.

    A discussion of risk cannot be done in a blog post or one chapter of a book. It is a vast subject and risk means different things to different traders.


  2. Peter,

    Keep in mind that long only strategies can only make money when the market goes up. Trend following strategies, on the other hand, can make money in up or down markets. Obviously, this trait of trend following strategies can be a “force multiplier” with respect to profit. Paired with leverage and good money management, trend following enjoys a logical (not to mention an epistemological) advantage over “buy and hope” strategies.


  3. I agree that trend following should not show large drawdowns. My RIX Strategy gets me out early and avoids large drawdowns. If you can identify changes in the trend of the overall market you should not have large drawdowns. I have been doing that for over 40 years.

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