Thursday, November 29, 2012

Trend following - dead again???

I've noticed in the last few weeks that some articles are springing up stating that trend following is dead (again). Articles such as these appear every so often following a period of poor performance by the CTA community and other traders who utilise such a strategy.

I suspect this time round they are also pointing to the recent decision by long-term trend follower John W Henry to close his trading firm to outside money, and to return what funds are left to investors (refer to story here).

Why is this? Trend followers need trends! The basic truth is that without a decent trend, a trend following system will fail to generate profit signals, as a combination of higher than ideal volatility and a lack of a general 'drift' in the price data will result in stops being triggered before a decent trend does take off, or a sharp reversal in an instrument's will not allow such a system to generate a profitable exit signal. In the latter case a pure trend following system does not use price targets which means that profits can easily be eroded in a short period of time. In short, if the market conditions are not conducive, then a trend follower will struggle. However it is also true to say that following a period where there are no trends, then a trend will appear. It is the amplitude of the trend that is unknown - it could last a week, it could last 6 months.

It is for this reason that I prefer to trader equities, as it is a lot easier to generate a multiple R profit in such an instrument compared to say trading an index or a major FX pair. They do bring their own issues, such as price gaps, but that is why you need robust risk management when trading. However, that does not make me immune from periods of poor performance. The truth is that trends will appear in any instrument, but you just don't know when. So, if you are trading such a system, you need to observe the entry signals presented and act on them (while using strict risk control) and see what occurs. That's all you can control.

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