Monday, November 21, 2016

Trend following, unrealistic expectations and a look into a fund's performance

Some people have unrealistic expectations when it comes to trend following - and trading in general, for that matter. 

I remember a trader contacted me once about some mentoring and essentially was looking for some assurance that, if he adopted a trend following approach, he would be able to make a +100% return over the next year.

While it is possible that, in strongly trending market conditions, you can make such a return, the reality is that the vast majority of the time you will be stuck in a drawdown, taking small loss after small loss, and that almost all the returns generated will come from a very small selection of the total trades taken.

Most people cannot accept that - they want instant action, and instant returns. 

In this post I talked about how trend followers have to go through periods of poor or non-performance when trends are not apparent in the markets they are following.

As an example, one such trader is Mark J Walsh.

While not classified as an original 'Turtle', Walsh was an associate of Richard Dennis in the 1980's, and has utilised a trend following strategy in his fund over the last 30 years or so.

Below is a summary of the performance for his Standard Program:

  • The overall return generated since 1990 is over +3,400%;
  • The biggest drawdown was -43.04% is 1993/94 - this included a single month's drawdown of just over 20%;
  • After making +50% in 2008, he has since had 5 losing years and only 2 winning years. He is currently down just below 6% year-to-date in 2016;
  • Yet over that same period, his overall returns are positive, as the returns in the two winning years far outstripped the losses suffered in the other years;
  • While the exact timing of entries and exits may differ, and the funds may trade multiple trend following systems on multiple timeframes, the vast majority of funds will be looking at the same markets. As a result, if a significant trend develops, then they will all be trading those markets in the same direction;
  • To give a specific example, the standard program generated positive returns from August 2014 through to January 2015. That coincided with the strong downtrend in crude oil. Go look at the monthly performance records of other trend following funds and you will see positive performance around the same time.
Now, this is the track record of one of the most successful trend followers out there. Yet he loses for more often than he wins. I know people who have tried to adopt a trend following method to their own trading and struggle with a losing week!

Trend following's robustness comes from:
  • its ability to go through these non-trending phases and then outperform when market conditions change;
  • risk control being an integral part of the overall process;
  • despite typically having a low win rate, the ability to cut losses and let profits run generates an overall positive expectancy or 'edge';
  • discretion being kept to a minimum, particularly when it comes to execution of entries and exits.
As a result, they accept they may have to suffer a losing year (or even longer) to get through to those big trends - and big returns.

So, if you are looking to adopt a trend following approach, then you will have to accept this too, or else you are wasting your time, effort and money.

1 comment:

  1. Great commentary for traders here Steve. It reminds me of Nick Radge's book Unholy Grails. It took me some time to accept it, but once I truly realized that every trading system has pros and cons, my emotional experience in the markets became much more manageable.