Trend Following

F o r e w o r d b y B a r r y L . R i t h o l t z x v P r e f a c e x i x Section I Trend Following Principles 1 1 Trend Following 3 Speculation 3 Winning versus Losing 9 Investor versus Trader 10 Fundamental versus Technical 11 Discretionary versus Systematic 15 Hiding in Plain Sight 17 Change Is Life 19 Follow the Trend to the End When It Bends 22 Surf the Waves 26 2 Great Trend Followers 31 David Harding 33 Bill Dunn 37 John W. Henry 49 Ed Seykota 62 Keith Campbell 69 Jerry Parker 74 Salem Abraham 75 Richard Dennis 77 Richard Donchian 83 Jesse Livermore and Dickson Watts 87 3 Performance Proof 91 Absolute Returns 92 Volatility versus Risk 93 Drawdowns 99 Correlation 104 Zero Sum 106 George Soros 108 Berkshire Hathaway 111 4 Big Events, Crashes, and Panics 117 Event 1: Great Recession 119 Event 2: Dot-com Bubble 132 Event 3: Long-Term Capital Management 145 Event 4: Asian Contagion 157 Event 5: Barings Bank 161 Event 6: Metallgesellschaft 164 Event 7: Black Monday 167 5 Thinking Outside the Box 177 Baseball 178 Billy Beane 180 Bill James 181 Stats Take Over 183 6 Human Behavior 189 Prospect Theory 190 Emotional Intelligence 195 Neuro-Linguistic Programming 197 Trading Tribe 197 Curiosity, Not PhDs 199 Commitment 201 7 Decision Making 205 Occam's Razor 206 Fast and Frugal Decision Making 207 Innovator's Dilemma 210 Process versus Outcome versus Gut 211 8 The Scientific Method 215 Critical Thinking 216 Linear versus Nonlinear 217 Compounding 222 9 Holy Grails 225 Buy and Hope 228 Warren Buffett 229 Losers Average Losers 231 Avoiding Stupidity 236 10 Trading Systems 247 Risk, Reward, and Uncertainty 248 Five Questions 252 Your Trading System 263 Frequently Asked Questions 264 11 The Game 273 Acceptance 274 Don't Blame Me 276 Decrease Leverage, Decrease Return 277 Fortune Favors the Bold 278 Section II Trend Following Interviews 281 12 Ed Seykota 283 13 Martin Lueck 295 14 Jean-Philippe Bouchaud 311 15 Ewan Kirk 319 16 Alex Greyserman 335 17 Campbell Harvey 353 18 Lasse Heje Pedersen 367 Section III Trend Following Research 381 19 A Multicentennial View of Trend Following 383 The Tale of Trend Following: A Historical Study 385 Return Characteristics over the Centuries 388 Risk Characteristics over the Centuries 398 Portfolio Benefits over the Centuries 400 20 Two Centuries of Trend Following 405 Trend Following on Futures since 1960 408 Extending the Time Series: A Case-by-Case Approach 412 Trend over Two Centuries 417 21 Trend Following 425 Introduction to Different Trend Following Models 425 Diversification between Different Trend Following Models 427 Aspect's Approach to Trend Following 429 Aspect's Model Compared to Other Trend Following Models 431 22 Evaluating Trading Strategies 435 Testing in Other Fields of Science 435 Revaluating the Candidate Strategy 437 Two Views of Multiple Testing 440 False Discoveries and Missed Discoveries 442 Haircutting Sharpe Ratios 444 An Example with Standard and Poor's Capital IQ 445 In Sample and Out of Sample 446 Trading Strategies and Financial Products 447 23 Black Box Trend Following--Lifting the Veil 451 The Strategies 452 Performance Results and Graphs 456 Sector Performance 458 Performance of Long versus Short Trades 461 Stability of Parameters 463 Are CTAs a Diversifier or a Hedge to the SP500? 466 24 Risk Management 471 Risk 471 Risk Management 471 Optimal Betting 473 Hunches and Systems 473 Simulations 474 Pyramiding and Martingale 474 Optimizing--Using Simulation 475 Optimizing--Using Calculus 477 Optimizing--Using the Kelly Formula 478 Some Graphic Relationships Between Luck, Payoff, and Optimal Bet Fraction 479 Nonbalanced Distributions and High Payoffs 479 Almost-Certain-Death Strategies 480 Diversification 482 The Uncle Point 482 Measuring Portfolio Volatility: Sharpe, VaR, Lake Ratio, and Stress Testing 483 Stress Testing 484 Portfolio Selection 485 Position Sizing 485 Psychological Considerations 486 25 How to GRAB a Bargain Trading Futures . . . Maybe 489 How to GRAB a Bargain Trading Futures 490 Following Trends Is Hard Work 490 Figuring Out How the Pros Do It 491 A Computer Model of the Pros 492 A Terrible Discovery 493 Solving the Mystery--Why Does the GRAB System Lose? 494 Often It Is Out of Sync with the Market 494 Worse Still, It Misses the Best Moves! 495 Maybe Being Profitable Means Being Uncomfortable? 496 GRAB Trading System Details 496 Buys on Break of Support, Sells on Break of Resistance 496 Testing Reveals Some Behavior I Do Not Expect 498 Difference between Parameter Values Defines Character of GRAB System 498 GRAB Trading System Code 500 26 Why Tactical Macro Investing Still Makes Sense 503 Managed Futures 504 Defining Managed Futures and CTAs 507 Where Institutional Investors Position Managed Futures and CTAs 507 Skewness and Kurtosis 507 Data 509 Basic Statistics 510 Stocks, Bonds, Plus Hedge Funds or Managed Futures 511 Hedge Funds Plus Managed Futures 512 Stocks, Bonds, Hedge Funds, and Managed Futures 513 27 Carry and Trend in Lots of Places 533 Carry and Trend: Definitions, Data, and Empirical Study 536 Carry and Trend in Interest Rate Futures 539 Trend and Carry across Asset Classes 541 Carry and Trend across Rate Regimes 545 28 The Great Hypocrisy 549 Epilogue 569 Afterword by Larry Hite 575 Trend Following Podcast Episodes 579 Endnotes 583 Bibliography 621 Acknowledgments 635 About the Author 639 Index 641