Trends are back!

Treasuries forever 

Perhaps nothing defines the power of trend following as well as the rally in fixed income. The long-term bond rally was supposed to be dead because the Fed was slowly reducing its purchases of long-term Treasuries. Few analysts saw bonds moving up; it was simply a matter of the pace of the decline. But trend followers don’t have to make a fundamental case for a move, they just need to recognize a trend and exploit it. That was true for Treasuries as well as other sectors. 

Kuen-Yih Hwang, principal of QQFund.com (+87.01% in 2014) trades 10-year notes and the Nasdaq 100 in a risk parity and trend-following strategy. “We made a bet that 10-year [notes] would go up in 2014. Trend following in equities was good,” Hwang says. He was long the Nasdaq 100 and 10-year note for most of the year and overweighted bonds in the October move.  It worked, as they were up 19.86% in October. 

 “Once the U.S. government announced tapering, the conventional wisdom was that interest rates in the United States are going up; well, they are not,” Waksman says. “Once you had all the unrest in the Middle East the conventional wisdom was that energy prices are going up.”

Waksman points out the benefits of systematic trading exploiting market moves without the noise of expectations. “With QE you had conventional wisdom that it would lead to hyperinflation, gold is going through the roof, the stock market is going up. Yeah [stocks are] going up in the United States but not in other places. You can go on and on,” he says. 

The point being trend followers exploit trends, which are not always rational and usually overshoot. During the fall nearly all the experts saw $80 as the absolute bottom crude oil could go. Trend followers weren’t necessarily smarter than all the experts; they simply just hopped upon the trend and let it take them where it was going. 

“The classic is energy,” says Levitt. “Finally the imbalances between supply and demand, [stalling Chinese] growth and fracking — that mismatch caused people to think about supply and demand. Saudis weren’t going to be a swing producer and it created a hell of a trend.” 

And once those forces are in play it is nearly impossible for producers to alter it. “To say because it costs $50 or $60 per barrel it is some kind of floor—that has never been the case. Especially when people have bonds to pay. They need the cash flow, people have done irrational things for a while,” Levitt adds. 

The point being producers are not going to shut down the minute price drops below their comfort level. They need revenue more than ever. They already spent the money to get those wells producing and now need the revenue regardless of the price they will receive. 

“That is what is great about trend following,” Wieczorek says. “We look like rock stars because we caught that move. It is not predictive, we just took the signal. Most trend followers got short anywhere from $90 to $100 per barrel and it closed out the year at $45 per barrel. Markets can move much much further than anyone expects. Even the most bearish Wall Street analyst predicted crude to finish the year at $85 to $90. That is the thing about markets; they try to inflict the most pain across the most traders.” 

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About the Author

Editor-in-Chief of Modern Trader, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board