Your Trend is Different to My Trend

At first glance, trends might seem straightforward, but they’re anything but. Confusion by practitioners often stems from the multifaceted forms trends can take, influenced by various market forces and events.

Some trends emerge from significant market transitions, signalling a shift in the underlying dynamics. Others arise within more stable and predictable regimes, offering a different set of opportunities and challenges for traders.

A common misconception is that all trends are alike. Many are directional shifts within larger cycles of mean reversion, where prices oscillate around a central equilibrium, creating patterns of convergence. In fact, convergent trends are regular occurrences in the markets, and you find their convergent behavior arising from price behavior found in the peak of the market distribution of returns.

These convergent trends are generally more frequent, predictable, and easier to navigate. They follow linear rules, are predictable in nature both in form and duration, adhering to established rules of market behavior, making them attractive targets for some types of trend follower. In contrast, trends distinguished as Outliers represent the exceptions to these predictable rules. These anomalies break away from typical market patterns, resulting in less frequent, unpredictable, and more volatile trading conditions. Their behavior cannot be predicted using linear models and they are wildly nonlinear in nature. They’re the wild cards of the market.

The key to differentiating between these trend types lies in understanding their distribution within market returns. Convergent trends cluster around the central peaks around the equilibrium of stable regimes, embodying the bulk of market movements, while outliers are found in the tails diverging away from prior equilibriums, marking extreme deviations.

These latter forms of trend represent market shifts or transitions between periods of more stable regime. The linear (predictable) nature of convergent trends makes them more accessible and manageable for traders, who can apply a set of rules to guide their trading decisions. These ‘convergent’ trends conform to the general expectations of market behavior.

Outliers, however, demand a different approach. Their non-linear and unpredictable nature requires an opposite approach paying strict attention to mitigating adverse risk events while letting profits run of these enduring yet unpredictable price moves. This diversity in trend types means that dependent on which opportunity you are exploiting, you won’t be singing from the same prayer book.

There isn’t a universal strategy that works for both classes of trend as they are being drawn from different regions of the distribution. Instead, traders need to appreciate the differences and embrace the fact that some Managers say Tomato and some Managers say Potato. That is a consequence of these differences. Views of the extent of diversification to use, whether or not altering position size post entry to manage risk, whether to use stops or not, whether or not correlations can be used to mitigate portfolio risk…. are all going to pivot around what type of trend following floats your boat.

For convergent trends, strategies might focus on exploiting the predictability and stability of the trend, using well-defined rules to guide trading decisions. These trends offer a clearer path to potential profits. Navigating outlier trends requires a more agile and defensive approach. Given their unpredictable nature, strategies must be adaptable, often incorporating more robust risk management techniques to safeguard against sudden market shifts.

Understanding the distinct nature of each trend type is not just an academic exercise; it’s a practical necessity for developing effective trading strategies.

Let’s just accept that the trend I might be targeting may be different to the trend you might be targeting. Once we understand the nature of these differences then we might be more willing to accept that the trend following is a broad church.

 

 

 

 

 

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