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Is trend following still alive?

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Attain Capital Management has put out a quality piece of research named Is Trend Following DeadBasically, the argument goes that trend following programms are in noticable drawdown and historically this has been a good entry point to invest in such programms. And an implication that nothing has changed, trend following is live and kicking and as sound investment approach as ever.

I would like to add shades of grey to plain black and white picture. Obviously, trend following is not dead. Many traders and asset management companies still use it as one of their principal strategies. Then there is the issue of the definition of trend following which is vague at best. Ed Seykota, probably the best known and the most respectable trend following apologist, says that the difference in price necessary to create the profit implies a trend. But, hej, this is true about any investment approach, not just trend following.

In Attain’s case the question of the definition is more straighforward — they consider the investment programm as trend following if the asset manager labels it as such. However, the question remains open what exactly are the  trend following strategies those asset managers use. Technically speaking, the only difference between high frequency trading and trend following may well be just timeframe. None provides a detailed description of the models used and  those may well have evolved beyond recognition from the original ones. In that sense trend following may not be dead but the inner workings of the system may well be a completely different from the classic notion of trend following.

Then there seems to be sufficient evidence that the returns from trend following systems are declining. This is a trend in its own right. If to draw a trendline on the chart (see below) from Attain’s research, the returns are in obvious downtrend and this may well be a secular trend which is not going to change.

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The Turtles are widely considered as the posterboys of trend following. They have been successful beyond doubt, but the returns from their system have diminished with time to reach a point where the returns are not competitive anymore. I’ve written about it before here.

Trend following is not dead. Traders still widely use it. But the inner workings of the system have changed over time beyond recognition and trend following today may well be something totally different from what it was decades ago. In terms of performance, the “classic” trend following has stopped working long time ago as can be seen from “the Turtle system” test results. And the chart from the Attain’s research may well serve as another evidence that the returns from trend following systems are on secular “downtrend”.

The trend following is not dead but in its classic form has decayed into useless and the modern version of trend following may be  different from other investment approaches in name only. However, nothing said here invalidates Attain’s suggestion that a bet on trend followers may be a good move now. Those asset managers are smart and rebound is highly probable.

Written by A.S.

November 7, 2012 at 8:30 am