Our View on Trend Following

We are duration-agnostic but condition-dependent.

Most momentum traders, or trend-followers, categorize themselves as long, medium, or short, term trend followers and approach markets with a view to predict and capture long/medium/short term trends.

Our view is that:

  • Like people, markets behave differently under different conditions,
  • Trends of varying durations are created under varying market-duress-levels,
  • An accurate assessment of a market depends upon distinguishing between the characteristics exhibited by that market under normal conditions, and those exhibited under duress.

By distinguishing market conditions, we gain the ability to apply a unique durational-trend following model for each unique level of duress exhibited by each unique asset within our asset universe.

While ‘duress’ for human-beings can be physical, psychological, or emotional, for the markets duress is almost always informational. Any disruption in the information flow that governs a particular market leads to idiosyncratic informational duress, and any disruption in the information flow that governs many markets leads to systemic informational duress.

Our proxy for the idiosyncratic informational duress is volatility of an asset, and our proxy for the systemic informational duress is its correlation to its peers.

We measure our skill through our ability to:

  • Distinguish market conditions according to varying degrees of duress,
  • Apply a unique trend following model for each unique level of duress exhibited by each unique asset within its asset universe.

Beyond these parameters, however, we must play by the rules of the Momentum game. The risk/return profile of a momentum strategy is akin to that of a long option strategy. The constant premium one must pay to play this game is a drag on returns; the trick, however, is to make sure that this drag is manageable and more importantly stretchable over a long enough period of time so as to maximize the probability that the option payoff exceeds the option premium.