Book Reviews

Andreas F. Clenow – Following the Trend – Review

Andreas F. Clenow - Following the Trend - ReviewI recently read and reviewed “Stocks on the Move” (2015), which is another book from the author. This one is not so much about stocks, but more diversified about managed futures trading. I liked the other book from Clenow so I decided to get this one, too. It was published already back in early 2013. I don’t mind reading an older book even if the markets change all the time, cause there’s often timeless wisdom in the thought process of experienced traders. However, the timing of this book was interesting, because the period between 2013 – 2018 was not favorable for the industry overall due to suppressed volatility by monetary policies. So it’s even better to read the book now and see how the out-of-sample period has been playing out to date.

Classical trend-following

Being diversified and trading “everything” is the core principle of classical trend-following. One needs at least couple of millions of dollars to trade all the futures markets with portfolio risk and volatility that make sense. Volatility becomes the main factor when comparing running a money management business to trading one’s own account. Clients just won’t stick with the fund if it goes through deep drawdowns in order to have higher returns. This is something I’ve thought about before and written in my blog about, the idea that most large fund managers care about the size of their AUM and try to do just as well or little worse than the benchmark to keep their clients with a smooth equity curve. Receiving management fees from their high AUM makes them more money than trying to have higher returns and possibly scare clients away. Another factor is that funds need a good story about their method to market it while a private trader just needs an evidence-based strategy to make money.

Futures are not as complex as it may feel at first

The author explains how futures work, what the terminology is and why not to hold a futures contract into delivery if you are a financial trader. Basically, you need to roll over your current contract to the next one before expiry, but nowadays brokers already offer it to be automatic or even provide a ticker for continuous futures contracts that never expire. Nevertheless, it’s good to understand how it all technically works before starting to trade this instrument. Futures are leveraged products and a trader needs to take this into account to manage risk when opening a position.

Clean data is important in backtesting

Just like with stocks, backtesting on futures needs proper price data. The issue with getting all the data is usually not having the delisted companies for stocks, and having different contract periods for futures that have rolled over to the next one and so on. An analyst needs proper datasets for backtesting to have confidence that the simulations have statistical validity to trade these probabilities going forward. If one backtests on random data, the outcome of the test will also be random.

Andreas puts futures into five sectors

1. Agricultural commodities that include softs, meats, grains, fibres.
2. Non-agricultural commodities that include energies and metals.
3. Currencies like EUR/USD, EUR/JPY, AUD/USD etc.
4. Equities like S&P 500, Nasdaq 100, FTSE 100, Nikkei 225 etc.
5. Rates like bond and interest futures.

Market diversification is a necessary component

Trend-following futures trading is based on diversification and one needs to trade everything. Nobody knows which market will offer the next outlier trend, therefore CTAs treat all the markets the same, meaning they apply a technical strategy across all the markets, sizing their positions based on volatility of the underlying price action. Another important thing is that futures traders are usually direction agnostic, meaning they go long or short in a market based upon the trend.

Keep it simple

The author lists some known CTA funds with their great track records, significantly outperforming the US equity market index. He reveals the truth that their strategies are actually highly correlated and not hard to replicate for even a retail trader, who is willing to do some programming and backtesting. If one has the diversification, buy-sell rules, proper risk management and position sizing, then it’s all up to loyally following the strategy through ups and downs. It’s usually the human mind that is seeking for something complex and better, especially during poor performance, that eventually can ruin a good trend-following trading system.

Ignore the short-term volatility

Andreas presents a simple but effective strategy that significantly beats the MSCI World index (18% annually vs 5%) in his 20-years backtest run at the time of writing (2012). He goes through the strategy’s performance year by year, which is a helpful exercise to see how trading actually looks like in real life, and it’s not as smooth as one would think looking at a long-term equity curve. There are so many bumps along the way, the value of his portfolio going up and down from negative to positive and back to negative in short-term, still making a great return over the whole period. It has performed less against equities in the following period since 2012, because equities have done very well and commodities on the contrary not, but the out-of-sample results continue to be strong and robust.

This book was a good and practical read to understand classical trend-following and futures trading. Though most of the content was already familiar to me due to studying futures traders and learning a lot about the industry during the past couple of years, I can recommend the book to anyone who wants to pick up knowledge in this field.

Following the Trend by Andreas F. Clenow book link

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