Volatility by Design

The past couple of months have been tough on trend-followers, myself included. The sharp reversals in interest rates, equities and currencies accounted for most of the losses.

While the very recent performance has been painful, these “losses” from a trading perspective have simply been giving back some of the profits made over the past few years. No one likes giving back profits, but it’s often the price to pay for capturing a large chunk of the trend.

It’s also important to realize that despite a tough November and December, trend-following performance over the past few years has been strong. But these tough short-term periods, and I want to stress short-term here, often present great investing opportunities.

Sometimes confidence gets shaken when losses occur. That’s understandable. But it’s important to maintain a cool head and not make any rash decisions.

It’s important to realize that these tough short-term periods are expected — and are by design!

Because we don’t curve fit our approach to fit any specific situation, we can experience volatile swings like this. Trying to eliminate all negative volatility, an all-too-popular effort, typically leads to catastrophic losses at some point and many missed opportunities along the way.

That’s not a tradeoff I’m comfortable with.

A Buying Opportunity in Trend-Following

The BTOP 50, a popular index comprised mostly of trend-followers, currently sits in a -6.3% drawdown (as of Dec-23) and has returned -1.9% over the past 12 months. Since its 1987 inception, there have been 106 instances where the 12-mo return was negative (and that have at least 36-mo of performance after each instance).

The average return following a 12-mo negative return over the subsequent 36-months has been +17.8% with the return being profitable ~93% of the time (99/106).

Pretty good I’d say.

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Past performance is not necessarily indicative of future results

 

Of course, we don’t know what will happen over the next 24 months, but the odds favor a strong upcoming period for trend-following.

These are precisely the moments when we make mistakes — when recent performance stinks and our impatience and frustration get the best of us. It’s so so so important to stay level-headed and continue to do the right things.

 

 


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