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The Yin Yang of Trend Following – Flipping Statistics on their Head in the Garden of Good and Evil

Readers of this Blog would be quite aware now of the underlying philosophy of the systematic divergent trader.

  • They would be aware of the concern placed by divergent traders in using statistical techniques as a measure of predictive certainty;
  • They would be aware of many possible future paths called risk and not attracted to the myth of a single optimised future path called guaranteed profitability;
  • They would be aware that divergent traders seek abnormality and non linearity in market conditions for their survival as opposed to predictable normal market conditions;
  • They would be aware that we fully engage in systematic application as this technique predates on the rational mind and we need a technique that prevents second guessing ourselves and falling into the same trap;
  • They would be aware that trading the ‘normal daily churn’ of the market is a divergent traders worst nightmare resulting in progressive building drawdowns while market conditions remain ‘convergent’ and predictable in nature;
  • They would be aware that alpha in this divergent space relies on those unpredictable rare moments when markets become less efficient and crowd behaviour becomes more coordinated in nature;
  • They would be aware that diversification is not simply used to capture non-correlated return streams but more importantly used as a measure to shop far and wide across the liquid universe of the financial markets for trending conditions that ‘scream out at you’ and are more likely to be enduring events as opposed to random ephemeral chart patterns. As a result, you are less likely to ‘pull the trigger finger’ on everything that moves and hence restrict your trading activities to the meat of the larger trending condition;
  • They would be aware that we don’t pick tops and bottoms but rather focus our attention on the ‘middle meat’ of trends;
  • They would be aware that all our efforts are directed towards risk management where profitable outcomes are just a symptom of the process;
  • They would be aware of the ups and downs of a civilisation and have a two way approach of either long or short as they understand that while history may not repeat, it certainly does rhyme;
  • They would be aware that we focus on the Pareto principle and the outlier as a way to survive in this competitive landscape recognising that it is the anomaly where the long term success in wealth building lies, not the demand for immediate reward of regular and predictable cashflow; and
  • They would be aware that our philosophy is deeply couched in the principles of ‘cutting losses short and letting profits run’.

Now despite this awareness of the philosophies and practices that shape the systematic trend following mindset, it is tempting to conclude that we throw away all statistics that are representative of more ‘normal market conditions’ and only use exotic mathematics of chaos theory that are more appropriate for adaptive non-linear market conditions.

Well the problem is that no one understands how to apply these peculiar and complex adaptive models and we shy away from any purported mathematical  process that seeks to ‘enshrine’ the future in certainty.

We don’t however throw standard statistics out with the bath water. ‘Au contraire’ my friends. Standard statistical treatment defines a population of market participants that like to play in the safe fictional world of certainty and immediacy…….and we like to eat them…..for they are tasty.

Rather we use standard  statistical treatment to define what are regarded as ‘normal’ market conditions or standard Gaussian behaviour and use them to draw a line in the probability sand of participants where we define a safe predictable world as lying within and a hostile uncertain scary world as lying without. The majority of participants lie within but the real ugly weirdos lie outside that line in the sand.

We flip the statistics on their head using the Yin Yang of it all and simply use it to define that region where traders like to think they have a grip on a complex system and that region where ‘most traders’ fear to tread.

That region we inhabit is where the predictive models break down and any supposed grip of the notion of ‘certainty’ is lost. In that hostile environment the ‘certain trader’ is stripped of their life support systems where they become unstable, emotional and gripped in the primal nature of fear or greed. They just can’t think straight and while ‘predictably’ stunned in the headlights or running into brick walls, we simply cackle ‘You are on our turf now stranger, looks like we are going to be fed today folks’.

You have got to be real ugly and sinister to survive in this hostile world of uncertainty. No beautiful and elegant designs for pure speed and precision….but rather thick impenetrable skins, warts and tentacles and pointy bits…..and you only come out to eat at night.

But hey…..we have feelings too. Do you know what it feels like when all about you are feasting on certainty. I mean really know? We just sit on the sidelines with maybe a brother or two being lost to the ‘predictable cause’ here and there when it all get’s too much. Our brethren are ripped apart by you guys but fortunately the real stalwarts, the arcane magicians, the orgres and the orcs keep most of us on the one path.

I know, you white knights want us all gone and vanquished but that ain’t gonna happen anytime soon. Provided that this world of uncertainty remains hostile to you predictable folk we will always be out there just waiting……Wherever you go, whatever you do, we will be right here, waiting for you!

Sleep well and prosper. Nightie night.

Rich B

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