I recently had a nice long conversation with author Michael Covel for the podcast series he produces. Covel is the author of several books on trend following and one of the few people that follow the space who has developed a broader audience for his work.
In it we joked about the “one story” written about Commodity Trading Advisors in general and trend followers in particular. That story “Is Trend Following Dead” is written or floated every time the strategy goes through a rough patch like it has recently.
Oddly enough one of these stories appeared in the blog section of Futures Magazine recently. In “Observations on the death of trend following,” Brian Casselman did not really declare trend following dead but talked about the most recent difficult period and asked if something fundamentally has changed in the nature of markets and trends. The answer, to paraphrase Bill Eckhardt, is yes markets have changed as they constantly change. But so what. That is a positive for this strategy even if it has produced difficult choppy markets of late.
His blog was correct to point out specific characteristics of the current environment that may affect the performance of trend following managers but it also incorrectly assumes a high correlation in the broad universe of traders that can be characterized as medium- to long-term trend followers. As I mentioned in my conversation with Covel, every year including the most reason one, there are trend followers who knock it out of the park regardless of the broader environment for trend following.
The blog also misses the most important point and that is that trend following works because its practitioners do not claim to be able to predict what will happen with markets. They simply believe that markets tend to trend. They create systematic diversified models designed to take advantage of those trends when they occur.
The best trend following traders acknowledge that they have no special insight into markets and even that there is nothing particularly special about the entry models they create to spot trends. Their success depends on the risk management built around those more general entry signals. They will catch the inevitable trends and hopefully given back less when they end.
Casselman compares performance of the last 30 years, which is a bit of a danger. In 1980 a good year for a trend follower meant a 100% return, today a triple digit return would more likely lose an allocation than attract one. You can’t compare an era where CTAs would target 50% + returns with one where they target 10 to 15%. As with any analysis of leveraged trading strategies, you must look at it from a risk adjusted perspective. He didn’t seem to buy into the notion that trend following is dead but hedged his bets at the end leaving readers unsure of what his position was.
Casselman wrote, “The more things change – the less weight we can place on the past – and most of the big blow ups are a consequence of naively applying statistical methods (or yesterday’s strategies) to a world housing more Black Swans than ever before.”
It seems that line is supposed to be cautionary but I don’t think there is a better strategy than trend following in an environment housing more black swans.
Stay tuned for more insight into my conversation with Covel and why trend following is not given the respect it deserves.