Cross-Asset Trend Following


Following The TrendWhen I began talking about learnings how to build and test trend following systems a few months ago, more than a few people recommended I check out Andreas F. Clenow’s new book Following The Trend. Being the Amazon junkie that I am, I immediately ordered the $50 book. After speaking to Mr. Clenow through twitter and reading the preface, I realized that I was very much going to like his book. With that said, I thought it would be interesting to note what I highlight and learn from each chapter.

While I have read and highly recommend Trend Following by Michael Covel, that is pretty much the extent of my knowledge when it comes to trend following. I am certainly not an expert on any of this. It is possible that Clenow’s book will inspire me to completely change my investing strategy, but it could also turn me off to the systematic approach. While I feel that there are quite a few trend following applications in my current trading, I am still far from systematic, and I find that many of the discretionary decisions I make are wrong. That could be the result of inexperience or a flawed approach, but I am not smart enough to distinguish the difference at this point. My plan is to read this book with an open mind and see where it takes me.

“There is a group of hedge funds and professional asset managers who have shown a remarkable performance for over 30 years, consistently outperforming conventional strategies in both bull and bear markets, and during the 2008 credit crunch crisis showing truly spectacular returns.” – Clenow

If you have read Covel’s Trend Following, you know that mindset is probably the most important thing when it comes to trend following. Clenow opens his book by first explaining that these trend followers exist and then giving a brief overview of their strategy. If this book is going to build on Trend Following the way I am hoping it will, then it makes perfect sense that Clenow would begin by briefly rehashing what Covel has already covered.

“The difficulty of managed futures trading is largely misunderstood and those trying to replicate what we do usually spend too much time looking at the wrong things and not even realising the actual difficulties until it is too late. Strategies are easy. Sticking with them in reality is whole different ball game.” – Clenow

Many of the great traders interviewed in the Market Wizards books would back this up as well. Many of them claim that new traders tend to over analyze entry and exit points while things like risk exposure, position sizing, and psychology are largely overlooked. I tend to spend more time analyzing bases and buy points than I do position sizes.

Clenow also points out that it is less important which strategy you pick, but vitally important that you stick to it. Again here, I am afraid that I might be out of line. Am I considering moving to a more mechanical system out of frustration when I should be doubling down my focus on my current system? Or is this just the evolution of a systematic trend follower?

“The very concept of trend following means that you will never buy at the bottom and you will never sell at the top. This is not about buying low and selling high, but rather about buying high and selling higher or shorting low and covering lower.” – Clenow

This is the part of trend following that fits in with how I currently trade. I generally like to buy stocks breaking into new highs out of sound bases. I don’t bottom fish looking for bargains.

“With a diversified futures strategy you have a large basket of instruments to trade covering all major asset classes, making each single bet by itself almost insignificant to the overall performance.” – Clenow

Clenow explains that investors who trade very few markets are often forced to trade larger than they should in order to show respectable results. Trading just a few position sizes that are large enough to impact the bottom line greatly increases a trader’s risk of ruin. Clenow advocates trading many markets across many asset classes in sizes that are virtually meaningless in order to achieve diversification.

I am not sure I agree with this, but am interested to see where he goes with it. I like that he is pushing the concept of finding a slight edge and exploiting that small edge against thousands of positions. This approach reminds me of a professional blackjack player who plays thousands of hands to exploit a very slight edge over the house. It reduces the gambling aspect. Clenow continues by presenting an interesting argument against diversifying across only stocks.

“When the market gets single-minded, the correlations between stocks quickly approach one as everyone panic sells at the same time and then re-buys on the same euphoria when the problems are perceived to be lessened. In these market it matter little what stocks you hold and the diversification of your portfolio will turn out to be a very expensive illusion.” – Clenow

This makes perfect sense to me. When stocks crash, they all crash. Actually, even on normal days there seems to be a correlation among all stocks. But then again, couldn’t you just have a stock strategy that gets you out of the market when the major crashes happen? Couldn’t you just go to 100% cash when the market is in a correction?

“There are times when it’s a good idea to participate in the general equity markets by buying and holding for extended periods of time, but then you need to have a strategy for when to get out of the market when the big declines come along, because they will come along.” – Clenow

That makes sense, but I don’t want to just buy and hold a basket of stocks. I prefer to buy the leading growth names when the market is in a confirmed uptrend. While I feel that there may be more opportunity available by opening up to more markets, I don’t believe there is such a severe downside as long as I go to cash when the market goes into a correction. I can, however, completely agree with Clenow’s view when it comes to standard buy and hold strategies.

“A solid managed futures strategy has a reasonably high expected yearly return, acceptable drawdown in relation to the yearly return and lack of significant correlation to world equity markets, and preferably slightly negative correlation.” – Clenow

Again, if you read Covel’s Trend Following, there is nothing new here. Covel proved through the performance histories of many trend following funds that this is an effective investment strategy.

“We are not dealing with mathematical certainties here and we are not trying to predict the future. What we are doing is try to tilt the probabilities slightly in our favour and then repeat the same thing over and over a large number of times. There will be years that are very bad for trend followers and there will be very good years. Over time the strategy is highly likely to produce strong absolute returns and to outperform traditional investment methods, but we are dealing in probabilities and not in certainties.” – Clenow

Again, I am reminded of the professional gambler who looks for a tiny edge and then attempts to exploit that edge over the course of thousands of plays. Had I not already studied Covel’s Trend Following as well as the Market Wizards series and multiple other books and podcasts, this would have been a nice, quick introduction to the world of trend following.

“Given that you can charge other people for managing their money along with your own makes the prospect even more appealing, because it gives you an income while you do the same work you might have done yourself anyhow, and apart from your own gains you participate in your clients’ trading gains as well.” – Clenow

Clenow spends the rest of the chapter discussing the advantages of running a trend following fund as opposed to just managing your own account. He explains different ways to do this and makes it clear that the goal of the book is to help the reader start a fund. I am not sure that I am interested in starting a fund, however I am not opposed to the idea either, so I will keep an open mind as we proceed.

While this chapter didn’t contain anything I haven’t heard before, it was a very nice review of the basics of trend following and would be a necessary introduction for anyone who lacked the previous knowledge that I began reading with. My expectation is that as I continue through the book, I will learn quite a bit about how to actually contract and test a trend following system. I have already received criticism that my SPY 10/100 Cross System is fatally flawed, and while I’m not sure whether that it true, I can’t wait to learn how to test it. I expect that this book is going to teach me.