Words of wisdom? “The trend is your friend”

The following is an extract from our research report: Do famous investment savings hold water?

“The trend is your friend” – WISE score: 11/15

Durability: 4/5

Just as the Flower Power movement began to lose momentum in the 1970s, trend-following strategies began to flourish. The futures market was blooming with new contracts, and the adage ‘the trend is your friend’ is likely to have become part of the vernacular.

However, trend-following as an investment idea was seeded over a decade earlier by investor Richard Donchian shortly after WWII. Despite its relatively late bloom, similar approaches were used decades beforehand; including by the legendary late-19th to early-20th-century trader Jesse Livermore.

Reliability: 4/5

Investing for the long term is a philosophy that you will find many investors claim to abide by, but the behaviour of market participants suggests otherwise.

Many times in the past the industry has heard calls for ‘the death of trend-following’ and many investors have ditched the strategy, causing waves of fund closures. Maybe investors are harnessing a mantra closer to ‘the trend is your friend until the end, when it bends’?

But an interesting paper written this year covering data back to medieval times shows that the strategy has worked through the ages using medium-term look-back periods. So perhaps the weakness seen over the past decade or so is just a bump in the road on an otherwise successful investment journey.

Insight: 3/5

The proverb is not a winner in and of itself. The aforementioned Jesse Livermore used trend-following (alongside other price-driven strategies) and blew his accountup multiple times over his long career.

It is incredibly important to be thoughtful in the implementation of trend as an investment strategy, and there are many design choices that determine the likelihood

of success. Some of the important considerations include signal generation, look-back period, diversification, dynamic/static positioning, risk management approaches, and – for the asset-allocator over any serious time horizon – fees.

Our low-cost approach to trend-following couples dynamic medium-term signals with a strong risk management framework and pragmatic diversification.[1] Despite recent weakness felt across the trend-following industry (ourselves included) we are not yet ready to throw the baby out with the bathwater.

 

[1] It should be noted that diversification is no guarantee against a loss in a declining market.