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Victor Niederhoffer on Trend Following

Sometime back we outlined insight into Vic Niederhoffer. Here he offers MSN Money a critique of trend following:

http://moneycentral.msn.com/content/P22198.asp

TurtleTrader comment: Sure trends turn. The point is? Do you think trend following doesn’t account for such? Trend followers don’t follow crowds. They take advantage of crowds. And profit.

The stock market has been a trend-follower’s dream for the last few weeks.

TurtleTrader comment: The last few weeks? Is that the time horizon one must have?

On March 22, a close below 1,150 in the SP 500 futures set all the bearish indicators in motion. Confirmations of a downward trend through regression lines, moving averages, pivots, Bollinger bands, you name it, were triggered. Over the next 24 trading days, the market closed 10 times at 20-day lows.

Rule No. 1, carved in stone for all technical analysts, is that the trend is your friend. If ever there were a time that we could, along with the Cabot Market Letter, report the beauty of using a simple trend-following indicator that makes it virtually impossible to miss a major market move, this would surely be that time.

TurtleTrader comment: So now is different? This time is different? Why?

No wonder that 830 aspiring chart-readers, the most ever, registered for the Market Technicians Association’s annual competency exams on April 26 in Jupiter Beach, Fla.

Granted that some users of trend following have achieved success. Doubtless their intelligence and insights are quite superior to our own. But it’s at times like this,

TurtleTrader comment: What is unique about this time? Have markets now changed?

When everything seems to be coming up roses for trend followers’ theories and reputations, that it’s worthwhile to step back and consider some fundamental questions: Is their central rule, The trend is your friend, valid? Might their reported results, good or bad, be best explained as due to chance? But first, a warning: We do not believe in trend-following.

TurtleTrader comment: The existence of trend followers are optical illusions? 30 years of trend following results are chance?

We are not members of the Market Technicians Association, or the International Federation of Technical Analysts or the TurtleTrader Trend Followers Hall of Fame. In fact, we are on the enemies list of such organizations.

TurtleTrader comment: We are not your enemy. But your comments are off.

These posts on the TurtleTrader site, which describes itself as the world’s No. 1 source for trend-following, referring to an April 2001 interview with Vic in Technical Analysis of Stocks and Commodities are typical:

Niederhoffer says that trend following doesn’t work, and is doomed to failure, but he blew up his own trading account in a spectacular fashion.

Niederhoffer, like so many, ignores the bottom line success of trend following. To accept what Niederhoffer says is to ignore the existence of all trend traders

But trends always turn

TurtleTrader comment: It’s why trend followers make money. How could trend following win if it did not account for a trend turning?

Normally, after showing that all the evidence is against a theory, we would be content to end with a snappy conclusion to the effect of the trend is not your friend. Yet no fixed rule can be expected to last forever.

TurtleTrader comment: Trend following wins for it is flexible. It adapts to change.

Given that the evidence over the last 60 or 70 years is antithetical to the trend-followers on individual stocks — and that recent evidence on trends in the averages is equally unfavorable — is there any evidence that things are about to change?

TurtleTrader comment: We must expect the market to change into something that no one has ever seen before?

Looking at the performance of these stocks over the subsequent 16 months, through April 29, 2002, we found that the 20 best stocks of 2000 returned an average of -11%. Calpine(CPN, news, msgs), down 76%, PerkinElmer(PKI, news, msgs), down 76%, and Allergan(AGN, news, msgs), down 32%, were among the bests that stumbled. (The situation would have been even worse if such stocks as Enron, a stalwart member and top performer of the SP in 2000, had been included. Enron was delisted in November 2001, so we had to drop its bad results, which would have taken an additional 5 percentage points from the 20 best.)

TurtleTrader comment: It sounds like Victor is a long only guy?

Putting one consideration with another, however, there is no recent evidence of a regime shift.

TurtleTrader comment: Regime shift?

The weight of academic findings and practical results indicates that the tendency to mean reversion is intact. We conclude that evidence for all periods, all individual stocks, all averages and all new indexes that we might reasonably think of is against the trend-followers.

Our market shrink, Dr. Brett Steenbarger, whose work is often featured on MSN Money, frames the issue this way: Technical analysis is like an X-ray; it generates pictures of market conditions. Accurate diagnosis, however, must determine exactly how far conditions deviate from the norm and perform tests that cannot be conducted by radiology. For a trader to limit himself to technical analysis is like a physician limiting diagnosis and treatment to X-ray findings, he concludes. A picture may be worth a thousand words, but a positive finding on a blood test will never show up on the picture.

TurtleTrader comment: How can you take the above paragraph and determine what to buy along with when and how much? And then when do you sell?

The beginning of a month is always a good time for a trend to change, and that’s when we like to buy individual stocks.

TurtleTrader comment: If this the tip of the day, how much of what do we buy? Will you call when it’s time to sell?

In view of the recent negative trends,

TurtleTrader comment: What is a negative trend?

this seems like a particularly salutary time to participate in the 1.5 million percent-a-century juggernaut. We are very bullish for this year and the next, and we have been purchasing shares of companies that announce buybacks and biotech stocks with a preponderance of recent insider buying. Our buys in both groups are based on statistical studies that we have reported on in detail here over the past few months.

We will be pleased to send you our workout of the 20 companies in the SP 500 that were the worst in 2000, adjusted for survivorship bias. Please be free with your critiques and encomia, especially the latter, as we anticipate a deluge of vitriol from the trend-followers on this one.

TurtleTrader comment: No vitriol Vic. You just make no sense. We welcome feedback from readers.

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