Watch the following animated graphic from Morgan Stanley:
Notice the “steady” wording. This is misleading. The world is volatile. Volatility is the driver of trading profits. If you have no volatility, you have no profits. Further, the implication seems to be that you can actually end up with steady returns or some other form of comfort that volatility has been reduced.
Trend followers know the real world is not steady. The trend following plan of attack is predicated on a non-normal world. That’s a right. No normal distribution. A world with fat tails. A world where the unexpected 100-year flood happens every 3 or 4 years. While this might sound worrisome, it’s not if you have a plan.
In fact, we believe most people instinctively know the world is not steady as well. But when powerful brokerage firms provide slick marketing, in easily digestible form, people sometimes put their better judgement to the side.
Don’t Wait for the Rebound
“A trader may put too much energy into trying to protect a losing position, hoping that it will turn around, rather than saving energy by getting out of the trade. The unwillingness to face the truth and readjust to the new requirements of today’s market is a good example of the psychological defenses of denial and rationalization that lock the losing trader into repeating yesterday’s errors with yesterday’s strategy.”
Have the Sources of Return for Trend Following Changed?
“No, there is no evidence or logical way to support this. Starting from first principles, we know the source of return to trend following techniques results from sustained market price movements. Examination of recent and past data demonstrates empirically similar sustained price movements. Statistical examination of the distribution of prices also is similar over large enough data samples in that the kurtosis or fat tails? is also similarly present. From a fundamental perspective, we could summarize the majority of return opportunities falling into several categories: macro-economic changes such as interest rates, asset values, inflation rates, and relative currency valuations taking place over months to years; physical supply and demand imbalances such as for commodities including seasonal stress factors taking place over weeks to months; and short-term market phenomenon such as liquidity contractions generally lasting from weeks to months. The common thread woven throughout these is the sustained change of price resulting from future unknowable events. Human reaction to such events, and the stream of information describing them, takes time and runs its course unpredictably. The resulting magnitude and rate of change of price is not reliably foreseeable [which is why trend following works].”
Patrick L. Welton
Welton Investment Corporation
Trend Following Products
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