Trend Following: working since the beginning of time
I tend to daydream.
The other day I zoned out and next thing I’m wondering what it would have been like to have dinner with Julius Caesar (and speak Latin).
As I snapped out of it, I wondered what system I would use to make a fortune in Roman times.
I’m a skeptic when it comes to the financial industry and ten years ago reverse-engineered hedge fund systems to see if they worked.
Some work very well I've found.
I've been fortunate to amass a not-so-insignificant sum and retired from engineering at the age of 34 using these systems.
So, I picked one of the methods I personally use and that probably has worked since the beginning of time because human nature hasn’t changed in the last ten thousand years, if ever.
Momentum, aka trend following.
Human nature has not changed
Markets exist because prices move around
If prices didn’t move there would be no need for markets.
But prices do move and on certain timeframes, when prices move higher they tend to keep going up and when they decline they tend to continue down.
Money, (i.e. GREED, our lovely innate human nature) chases after performance.
Remember the NASDAQ in the 90’s?
Look at the Dow in the 20’s.
Or the stock market right now.
Greed chases performance
Performance attracts more money like flies to you know what.
And the money created from this performance is attracted back, a feedback loop until it ends, usually in a spectacular bust.
It always ends, by the way.
You will hear how there is going to be a "paradigm shift" or that it's "different this time", but there is no paradigm that says something must go up forever.
Just look at Bitcoin and the cryptos, biggest bubble in human history, bigger than Tulip Mania from the 1600’s.
But as long as you are aware that the music will eventually stop, you can make a fortune.
"It's different this time" - the most dangerous phrase ever
The basic framework
To follow these moves profitably, you must have a time-tested system.
The basic framework is this:
1) Only buy assets that are going up (works better than down thanks to inflation)
i.e. only buy assets that are above their 200-day moving average
2) Buy when price closes at a new 10 day high (a “breakout”)
3) Sell when price moves below the price from 5 days ago (a “breakdown”)
Of course, you can massage those numbers to make a lot more money.
The values I use to invest in Gold are close but not exactly those above, you get the idea.
Trend following works when done correctly
Keep it simple
If there is one thing I’ve learned with all my success in the markets is that simple is not only better but more robust and more likely to continue working in the future.
Many people over optimize, curve fitting their rules, ending up with a pile of garbage that will drive their portfolio eventually to zero.
The trend following strategy I use to trade gold is simple and adaptive (thanks, machine learning!)
I won’t catch the bottom or the top of markets, but I will catch the meat of the move and that’s the important part.
The key is knowing where to apply a system
A trend following system is certainly what would work if you time traveled to the past and I’m willing to bet (since I use it every day) continue to work in the future.
It’s an unbelievably simple idea that often gets overlooked or completely over complicated.
Strange how that works sometimes.
As long as markets exist there will always be money to be made using trends.
The key is knowing what is a trending and what is a mean reverting market.
I would NOT use a trend system on the S&P 500 stock market which, as I’ve written about previously, is a mean reverting market.
Knowing when and where to ably these simple proven systems is the key to unlocking the power of markets and lasting wealth.