Making money from trends in financial markets – August 2018
The Winston Capital Guide to Trend Following and CFM ISTrends has been put together to help financial advisers understand why trends occur, how to make money from such trends, and how to integrate them into a portfolio of traditional assets using a Mean Variance Optimization methodology.
Put simply, trends exist in financial markets across multiple timeframes, geographies and asset classes including bonds, stocks, rates, commodities and currencies; no matter where you are in the world and no matter what the asset class, powerful behavioural forces exist that cause trends to form, pushing prices beyond what Eugene Fama’s Efficient Market Hypothesis (EMH) might suggest an asset price should be.
Are markets efficient, in the sense that all public information is included in current prices?
As Seager et al April 15, 2014 suggests, “If this were so, price changes would be totally unpredictable in the sense that no systematic excess return based on public information could be achieved. After decades of euphoria in economics departments (There is no other proposition in economics which has more solid empirical evidence supporting it than the Efficient Market Hypothesis, as M. Jensen famously wrote in 1978), serious doubts were raised by behavioural economists who established a long series of pricing “anomalies”. The most famous of these anomalies (and arguably the most difficult to sweep under the rug) is the so-called “excess volatility puzzle”, unveiled by R. Shiller and others. Strangely (or wisely?) the 2013 Nobel committee decided not to take sides, and declared that markets are indeed efficient (as claimed by laureate E. Fama), but that the theory actually makes “little sense”, as argued by Shiller, who shared the same prize! In the list of long-known anomalies, the existence of trends plays a special role. First, because trending is the exact opposite of the mechanisms that should ensure that markets are efficient, i.e. reversion forces that drive prices back to the purported fundamental value. Second, because persistent returns validate a dramatically simple strategy, trend following, which amounts to buying when the price goes up, and selling when it goes down.” Importantly, trend following strategies do not predict the movement of various asset classes, instead, they make money profit from trends when they are securely in place.