People question trend following:
Are the financial conditions that we are observing consistent with a less or more productive “trendiness”? Inflation, deflation and potential depression have changed the game? Financial uncertainty is creating bigger price moves? Is making money in trend following a phenomena that is only possible in inflationary conditions like the 1970s? Is there evidence that trend following works in other economic conditions?
Financial uncertainty? There always is uncertainty in all areas of life. There was uncertainty in the 1970s. There was uncertainty in the 1990s. Dealing with uncertainty is the root of trend following success.
Why Trend Following Is Built for Every Economic Condition
The question of whether trend following only works in inflationary conditions is one of the most common objections the approach faces, and it is based on a misunderstanding of what the approach actually does. Trend following does not bet on inflation. It does not bet on deflation. It does not have a view on economic conditions at all. It follows price trends wherever they occur, in whatever direction they occur, in whatever markets they occur. When inflation produces sustained uptrends in commodities, trend following captures them long. When deflation produces sustained downtrends in equities and commodities, trend following captures them short. The economic condition determines the direction of the trend. The approach captures the trend regardless of its direction.
The documented performance record of systematic trend following across economic cycles provides the empirical answer to the question. The 1970s produced inflation-driven commodity trends that trend following captured. The 1980s produced disinflation-driven bond market trends that trend following captured. The 1990s produced equity bull market trends and emerging market currency crises that trend following captured. The 2000s produced the commodity super-cycle, the equity bear market, and the global financial crisis that trend following captured. The 2010s produced low-volatility equity bull market conditions that were less favorable for trend following, followed by the 2022 inflation-driven commodity and rate trends. No single economic regime is required for trend following to work. Large, sustained price trends are required, and those occur in some form across all economic regimes.
The 1970s-only objection confuses the specific instruments that were most profitable during that period with the approach itself. The commodity trends of the 1970s were unusually large and unusually sustained. They were exceptional, not typical. The trend following approaches that profited from them were not specifically designed for inflationary conditions. They were designed to capture any large, sustained directional price move in any market. When other conditions produce other kinds of large, sustained moves, the same approaches capture those.
Dealing with uncertainty is the root of trend following success because the approach does not require certainty to work. It requires only that the trader be positioned in the direction of whatever trend is currently developing, with a defined exit when the trend reverses. Uncertainty about whether inflation will continue, whether central banks will tighten or ease, whether geopolitical events will accelerate or resolve, is irrelevant to the approach. The price will tell the trader what is happening. The rules will tell the trader what to do about it. The uncertainty is the environment in which the approach operates, not an obstacle to it.
Frequently Asked Questions
Does trend following only work in inflationary environments?
No. The approach works in any environment that produces large, sustained directional price trends, which occur across all economic regimes. Inflation produces commodity uptrends. Deflation produces bond uptrends and equity downtrends. Financial crises produce currency and interest rate trends. Policy uncertainty produces volatility trends. The specific instruments and directions that produce the largest returns vary by economic regime. The approach captures those trends regardless of their specific cause or direction.
How does trend following handle changing economic conditions?
By reacting to price rather than predicting economic conditions. A trend following system does not need to know in advance whether inflation or deflation is coming. It needs only to enter positions when price breaks above or below defined levels and exit when price reverses by the defined amount. When economic conditions change and produce new price trends, the system enters the new trends. The economic condition is the driver. The price movement is the signal. The system responds to the signal without needing to forecast the driver.
What evidence shows trend following works across different economic conditions?
The multi-decade audited performance records of systematic trend following managers across the full range of economic environments from the 1970s to the present. The approach produced returns during the inflationary 1970s, the disinflationary 1980s, the growth-driven 1990s, the crisis-driven 2000s, the low-volatility 2010s, and the inflationary 2020s. The returns varied in magnitude across these periods, and some periods were less favorable than others. None were periods of consistent systematic losses over a sufficiently long horizon.
Trend Following Systems
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