“We wish you a non-traditional New Year!”

Email in from a reader:

Hi Michael,

Thought you might like this from Man.

Have a great Christmas and keep up the good work.

Kind regards,

Excerpts from Man piece:

The turn of the year is when traditional long only money managers state their predictions for the year ahead. Equity managers may be bullish if stocks are cheap or central bankers are expected to flood the markets with money, for example. Or they may be bearish if value is perceived the other way. It may not be an easy task, but the manager can generally make a guess based on a reasonably sound and intuitive argument. For a trend follower, however, it really is hard to answer the question in a manner that would satisfy most people.

The reason for this originates in how trend followers trade…trend followers are typically long when a market is rising and typically short when a market is falling. This is achieved through a systematic, non-discretionary process where computer algorithms analyse historic data in order to identify trends lasting anything from a few days to multiple months, with an average of around two months. Of course, individual markets may not trend all the time, so trend followers diversify by trading a wide variety of markets over many asset classes. The intention is that, as long as these markets are lowly correlated, the trend-following net is cast as wide as possible, and trends are captured wherever and whenever they occur. The technique is applied to the most liquid instruments available, meaning the strategy itself is highly liquid.

So trend followers do not care whether markets go up or down as they can potentially profit either way. Trend followers do not care which markets trend, as they typically trade a range of asset classes. Trend followers do care about persistence. As long as trends last at least a couple of months, the typical holding period of a medium term trend follower, we are generally happy.

Our prediction for the year ahead is therefore based on the persistence of market moves, and what can give us any confidence in that? Quite a lot, as it turns out. First of all, there is theoretical grounding for the existence of trends through the field of behavioural finance, or because of the varying speeds of dissemination of information into markets for example. Second, and perhaps more persuasively, there is evidence of trends existing in markets for hundreds of years1. So although it may be difficult to think why trends may persist in the year ahead, history and theory are with you.

The differences in how traditional versus trend-following managers have to think about the year ahead is a manifestation of the different yet complementary approaches both take. As you might expect, different approaches lead to different return profiles.

…trend followers are typically uncorrelated to equities (and other asset classes for that matter) because trend followers can be long when prices rise and they can be short when prices fall. What is also clear is that when the S&P has its worst calendar years, trend following returns have tended to be strong. It would seem that when equity markets are in crisis, trends can be strong and trend followers can be profitable.

If you have been inundated with predictions from traditional managers for 2016, spare a thought for us non-traditional managers. We find it hard to give explicit catalysts for performance in the year ahead, and as such are reluctant to give forecasts…Trend following offers an uncorrelated return stream to equities, and can even perform strongly when equities are in crisis. Trend following is perhaps considered a non-traditional strategy but on these grounds it may well be a welcome addition to traditional portfolios.

A happy reminder of the efficacy of trend following.

Michael Covel
Michael Covel

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.