You Can’t Always Trend When You Want

Abstract

In this article, the authors present a novel framework to decompose the drivers of trend-following performance into (1) the magnitude of market moves, (2) the strategy’s ability to profit from those market moves, and (3) the degree of diversification across markets. This framework allows them to examine why trend performance has been below the strategy’s long-term average return during the recent decade. The authors find that the lower performance of the strategy is explained by neither (2) nor (3): Trend following has continued to profit from market moves and benefit from diversification. Instead, the primary explanatory factor is (1), namely, that the average size of global market moves has been more muted than usual. The fact that trend-following strategies continue to translate market moves into profits in a diversified manner suggests that trend-following investing may see stronger performance in market environments characterized by more pronounced movements in global markets going forward.

TOPICS: Performance measurement, style investing

Key Findings

• • We present a novel framework to decompose the drivers of trend-following performance. This framework allows us to examine why trend performance recently has been below the strategy’s long-term average return.

• • Recent lower performance is not explained by an inability of trend following to translate trends into profits or by a lack of diversification. Instead, the average size of market moves has been more muted and is the primary explanatory factor.

• • The fact that trend-following strategies continue to translate market moves into profits in a diversified manner suggests that trend following may see stronger performance in market environments characterized by more pronounced movements in global markets going forward.