Trend Following: Profitable Reality or an Illusion doomed to Failure?

My recent work has been designed to penetrate the heart of this topic: I have discussed and back tested random entries at some length, I have queried the use of back testing and I have tried to explain why, over the past 40 years, trend following seems to have become increasingly difficult.

One of my contacts (a highly intelligent contact at that) holds that trend following is a dangerous illusion:

A “single threaded” strategy, conceived by those deceiving themselves by believing that the market data is giving out "entry signals". While in the grand scheme of things they are just making random entries. The appearance of profitability is most often just “curve fitting”. In reality, in those cases, P&L is mostly oscillating around 0 (even though with large variance, large enough to create both dreams and defeats.)”

I am not sure that one can really describe a random entries system as a single threaded strategy. In many thousands of back tests I appear to have shown that entries coupled with a wide trailing stop seem to be profitable. It may be however that the very nature of trend following (running profits and cutting losses) is "single threaded" and a dangerous illusion?”

"Single-threaded" is a terminology that my contact uses to denote a "class" of strategies which have the following features: (1) There is one and only one "trade" at a time for each instrument (2) A "trade" is defined by an "entry" and an "exit". (3) Normally, entry is triggered by some "signal" and exit is triggered by "taking profit" or a stop ( the latter can be read as "taking a loss").

So to take that a stage further, my contact concludes that over the long term trend following is a zero sum game and an illusion fostered by curve fit back testing. And that if one conducted enough tests on random entries using a simple trailing ATR exit, the average CAGR would equate to zero. The same goes for any trend following system tested on a wide enough range of data – presumably necessitating the supplement of “real” market data by synthetic data.

So, does back testing on historic data have any validity at all? And if it does, can the reality of trend following be proved or disproved in empirical terms using past data?

I have sought to bolster my bias in favour of trend following rather than to destroy it. I sought to test out the theory that random entry, using a wide portfolio of instruments, coupled with a simple ATR based trailing stop would prove profitable using a statistically large sample size of test runs and trades. I thought to show that “cutting your losses and letting your profits run” was a profitable strategy. But I can see how that may be thought of as a “single threaded” approach.

Is any back testing approach which can shed any definitive light on this matter? Can it be proved or disproved, using past data, whether trend following is a profitable reality or a dangerous illusion?

If “proof” is not possible one way or another, then back testing is indeed “a tool for fools”.

More of my ill conceived thoughts can be seen on my own website.

 

"...over the long term trend following is a zero sum game and an illusion..."

In the long run we are all dead (Keynes), but in the short run, "We must cultivate our gardens." (Candide, ou I'Optimisme by Voltaire) You know, clean out the ill thoughts so the good ideas can grow.

 

My contact dries out if I don't use drops.

"On a long enough timeline the survival rate for all backtests drops to zero."

 

If you flip a coin 10 times and get 10 heads, are you in a heads trend?

 

If your entries are random and/or use indicators to trigger an entry, then, yes, you'd probably end up at zero.

On the other hand, if your entries have a rationale and are made within the context of price movement, particularly against support or resistance, then your results would be quite different.

 

There is only so much room in the ecosystem for the same kind of predator. Trend followers also had a very suitable environment 15 years ago, but probably not 40 (during the sidewayz 70s)

 

IF you are selling to morons, you must do trend following. it's just so easy in hindsight to say...well, see this went higher and this low was higher and so you buy here and then stop here and here is where the trend stopped.

IF you try to trade yourself, you constantly ask, "does every idiot see this move and am I late?" You have no idea. If you buy....it might go straight up and you are happy. IF you buy and it goes down, you curse this trend stuff and wonder if anything works.

Some people are lazy and like to look for simple patterns and if anything this simple and dumb worked....then 90% would not lose.

So, listen the DOW is in an uptrend. You should all be super long from way below!!! Ok, not the beginning of the uptrend, but in the middle!!! Super easy!!! Why can't you see such an easy trend higher!!!! Now sell and retire....you just got thousands of points.

Oh, you want me to solve TA in one post!!!

My advise: Pick ONE stock.....bet it all.

 

Sounds like a pretty good trend when you can get head 10 tries out of 10.

...this is most definitely the holy grail.

 

The edge of trend following, albeit, very small, is that if something is trending it has slightly better chances of going the same direction rather than reversing.

However, going sideways is another outcome that is often overlooked and unless you prepare yourself for it, it can kill the already miniscule edge of trend following.

 

Are you insinuating that financial market returns follow a similar stochastic distribution as coin flips? That is absurd.