Jul

27

Trends, from Jim Sogi

July 27, 2013 |

Seems like the market has been rather trendy lately. Of course now that I've realized it its probably near the end of the trend. But that's the same thing I though at the beginning of the trend.

Mean reversion systems have difficulty in a trendy market, and simple TA things work well for trends if you're lucky.

Rocky Humbert writes:

Mr. Sogi writes: "Mean reversion systems have difficulty in a trendy market, and simple TA things work well for trends if you're lucky."

I suggest that Mr. Sogi should have written: "Simple TA things have difficulty in a choppy market, and mean reversion systems work well if you're lucky."

Every single profitable trade requires a trend!

If you buy at 9:30am at a price of 100 and sell at 9:31 at a price of 100.25, there was a one minute trend. Call it whatever you want. But if you have two points connected by a line, that line is a trend.

The carpenter ants that live in my yard don't know that my neighbor has much better foraging.

Steve Ellison writes: 

As I understand the premise of trend following, it is allegedly good to identify the trend in place before placing one's trade and enter the market on the side of that trend. To say every profitable trade requires a trend seems a tautology to me and not useful since the statement refers to the trend that occurs after entry and hence cannot be known at the time of entry.

Bruno Ombreux adds: 

Rocky,

This is a semantic debate. It all depends how you define a trend. "Point A to point B" is a "line", not necessarily a "trend". There are actually formal definitions for "deterministic trends" and "stochastic trends". There are also statistical tests to check the presence of those trends.

Mean-reversion: you can make money in a market going from "point A to point A" instead of "point A to point B". 

anonymous writes:

Having spent a number of years in the trend-follower business, I can confirm that trend-following, as practised by some rather large CTAs, means betting on markets where models suggest the continuation of a move. So if the price went up from A to B, a trend follower would make bets where the move from B to C is in the same direction, whereas a mean-reverting player will try trade instruments that he believes will move back towards A.

Over the years, I have given much thought to the workings of the whole trend-following business, and its role in the market ecosystem. The Chairman's various critiques of the style are all valid, and worth heeding. Yet, properly understood, I believe trend-following remains a valid approach to trading. i.e., it is a trading style that exposes you to risk factors for which the market is willing to pay you.

Rocky Humbert adds:

A wise man once said, "There ain't no point in beating a dead horse. But there ain't no harm in it either."

We've all had this trend following discussion ad nauseum in the past, and the chair's pathological aversion to trend following is well known. So to avoid re-opening old wounds, I will re-offer the single most plausible and economically rational reason why trend-following can work and has worked. (That is, I'm not saying anything about whether it still works or will work in the future.)

In order to move a price, the market requires new information. And this new information takes time to disseminate among market participants. And during this period of dissemination and acceptance of a new perception, prices will appear to trend. If you are the first person to acquire and understand this new information, you are said to have a variant perception. If you are the second or third person to realize that there is new information, you are called a trend follower. And if you instinctively fade this perception as it disseminates through the market, you are either called a contrarian or Anatoly. Strictly speaking, a true contrarian, like a stopped clock, is right twice a day. And while this new information is disseminating through the market, there are obviously many opportunitities to profit.

Ultimately, however, a trend-follower is economically equivalent to a person who buys synthetic options or volatility. And a mean-revision trader is economically equivalent to a person who sells synthetic options or volatility. Transaction costs notwithstanding, unless one has superior information, there is no apriori reason to believe that selling synthetic options should, over a career, be more profitable than buying synthetic options. However, the equity profile of an options seller is that of many small profits and a few big losses. Whereas the equity profile of an options buyer is that of many small losses with a few big gains.


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