TIP308: Trend Following Investing w/ Niels Kaastrup-Larsen (Business Podcast)

Podcast Summary

• Understanding Trend Following Investing: Trend following is a systematic approach to investing that relies on identifying and following price trends in various markets, emphasizing rules over emotions and the belief that anyone can learn to be successful with the right guidance.

  Key takeaway from our conversation with Niels Kostrip Larsen, a veteran of the finance industry and trend following investor, is that trend following is a systematic approach to investing that relies on identifying and following price trends in various markets. This approach, popularized by legendary trader Richard Dennis and his "Turtle" students, emphasizes the importance of rules over emotions and the belief that anyone can learn to be successful with the right guidance. Successful trend followers may adapt and improve their rules over time, but the core principles of the approach remain consistent. The Turtle project, which taught these principles to a group of students and allowed them to trade Dennis' capital, was a significant success, debunking the notion that successful trading is solely dependent on innate ability.

• Managing risk in trend following strategies: Firms like Don Capital have adapted to the challenges of trend following by focusing on risk management and effective trade exits, using sophisticated methods like the Kelly criterion.

  While trend following strategies have proven successful for firms like Don Capital since 1974, they come with their own set of challenges such as high volatility and the risk of significant losses. To address these issues and improve risk-adjusted returns, firms like Don Capital have made some major changes in the past 20 years, focusing on managing risk and getting out of trades effectively. Lawrence Lepard emphasizes that identifying trends is not the hard part, but rather determining the right position size and knowing when to exit trades is where the real challenge lies. They aim to deliver trend following in a better package by continually striving for improvement and applying sophisticated methods like the Kelly criterion to their strategies. Ultimately, the goal is to create a simple yet effective trend following approach that can handle the complexity of global markets while minimizing drawdowns.

• Adapting to changing market conditions in trend following strategies: Firms must systematize their trend following strategies, test strategies without discretion, and stay adaptive to market evolutions. Building a network of like-minded investors and staying informed through reliable financial news sources can enhance investment journey.

  Trend following strategies, which used to involve getting in and out slowly due to long-lasting trends, have had to adapt to changing market conditions. The optimal timeframe for these strategies has varied greatly from year to year, making it crucial for firms to systematize their approach and test what they trade without discretion. Markets continue to evolve, with this year seeing record-breaking sell-offs, emphasizing the importance of staying adaptive. Another key point is the value of community and resources in investing. As the market landscape becomes increasingly complex, having a network of like-minded investors to learn from and build relationships with can significantly enhance your investment journey. Lastly, staying informed is vital for making informed decisions. Utilizing reliable financial news sources like Yahoo Finance can help investors stay updated on market trends, major news events, and company developments, enabling them to make more informed investment decisions.

• Diversifying with Trend Following Strategies: Trend following strategies provide uncorrelated assets for risk-adjusted returns, but correlation can fluctuate and diversification within the trend following portfolio is crucial. Growing trend following businesses may face challenges in allocating to least correlated assets, but non-correlation is more important than excess return.

  Diversification is key to a successful investment portfolio, and trend following strategies can provide uncorrelated assets that enhance risk-adjusted returns. Trend following, which involves identifying and profiting from trends in various markets, has shown to have minimal correlation with traditional assets like stocks and bonds in the long run. However, it's important to note that correlation can fluctuate and trend following can be positively or negatively correlated with stocks and bonds at different times. Additionally, diversification within the trend following portfolio is vital, as trend following on a single market or sector may not be effective for long periods. The challenge for trend following managers is that as they grow their business, the least correlated assets, often in commodity markets, become too small for meaningful allocations, potentially leading to lower returns if they overstate their capacity. Finally, it's important to remember that non-correlation is more important than excess return, and trend following's ability to provide attractive returns while being uncorrelated with traditional assets makes it an essential component of a well-diversified portfolio.

• Consistent performance of commodities during crises: Historically, commodities have been the most consistent performing sector during market crises. Diversification and finding the right balance between it and conviction are essential for investors, especially older ones like Warren Buffett.

  While it may be tempting to believe that trend following strategies can yield significant returns during equity market drawdowns, historical data shows that commodities have been the most consistent performing sector during crises. Diversification is key, but finding the right balance between diversification and conviction is essential. Older investors like Warren Buffett, who have amassed significant wealth, can serve as examples of the importance of both. However, even with a long-term track record, there are challenges and lessons to be learned. For instance, the temptation to change strategies during losing periods can be costly. Trend following strategies have stood the test of time for Dun Capital's clients, with the firm's partnership approach ensuring that they only make money when their clients do. Over the past 45 years, Dun Capital has made significant improvements to its trend following strategies in 2006 and 2013. While past performance is not a guarantee of future results, the firm's long-term track record and continuous improvements demonstrate its commitment to delivering value to its clients.

• Trend Following Strategies' Performance in the Last Decade: Trend following strategies have delivered similar returns since 2013 with less volatility compared to previous 35 years. They've performed well during rising interest rates and offer diversification, but large long exposures can lead to significant losses.

  Despite the complaints about performance in the last decade due to central bank manipulation of markets, trend following strategies have delivered similar returns since 2013 as in the previous 35 years. However, these returns have come with less volatility, which is generally preferred by investors. Additionally, trend following strategies have performed well during periods of rising interest rates, which is an interesting point given the recent trend of negative correlation between stocks and bonds. It's important to note that this correlation may shift back to positive in the future, leaving little protection for traditional 60/40 portfolios. Furthermore, while equities have been a good place for trend following during periods of slow upward moves, they can also result in large long exposures right before market turns, leading to significant losses. Therefore, diversification is key for trend following strategies.

• Value and trend following: Two different investment approaches: Value investors buy low and sell high, while trend followers buy high and sell even higher, waiting for a market breakout. Marrying these strategies can provide diversification.

  Value investing and trend following are two different investment approaches. Value investors aim to buy in a falling market when assets are cheap, while trend followers wait for an upward market trend before entering. Value investors sell when the market becomes expensive, whereas trend followers stay in the trend as long as possible. An example of this is Tesla, which surprised many with its high price. The difficulty of assessing asset prices makes using rules rather than discretion an attractive option. Marrying these two approaches can provide diversification in investment strategies. While value investors focus on buying low and selling high, trend followers buy high and sell even higher, waiting for a market breakout. Public.com offers a high yield cash account with a higher interest rate than many competitors, making it an attractive option for investors.

• Understanding high-interest savings and smart financial decisions: Public.com offers a high-yield cash account, NerdWallet helps find smarter financial products, trend following strategies succeed in crises, successful trend following requires risk management, and effective risk management is crucial for individuals navigating the financial landscape

  Earning high interest rates on savings and making smart financial decisions are crucial for individuals. Public.com offers a high-yield cash account with a competitive interest rate, but it's essential to understand the details and trust the source. NerdWallet is a reliable resource for finding smarter financial products, such as credit cards with travel rewards. When it comes to investing, trend following strategies have proven successful during various crises, including Black Monday (1987), the tech bubble (2000), the great financial crisis (2008), and the ongoing COVID-19 crisis. However, it's important to note that each crisis is unique and presents its challenges. Successful trend following requires a solid risk management framework, as no investor can control the return on their trades. Stig Brodersen, a trend following expert, emphasizes the importance of risk management and being adaptive to various market environments. While trend following isn't perfect and may not perform well in all situations, it's an adaptive strategy that looks only at price and doesn't have preconceived notions about market direction. Overall, earning high interest rates, making smart financial decisions, and implementing effective risk management are essential for individuals navigating the ever-changing financial landscape.

• Combining value investing and trend following: Successful investment strategy includes value and trend following, especially during downturns. Trend following generates returns when other investments decline, but requires patience, long-term perspective, and sufficient capital to manage risks.

  A successful investment strategy often involves a combination of value investing and trend following, particularly during market downturns. Value investing may not perform well in a crisis, but trend following can help generate returns when other parts of the portfolio are declining. However, managing the risks associated with trend following requires patience, a long-term perspective, and sufficient capital to diversify across markets and timeframes. It's essential to recognize that trend following is not a hedge, but rather an uncorrelated return stream. The challenge for individual investors is that managing these strategies effectively requires expertise and resources, making DIY trend following a significant challenge.

• Embrace uncertainty and patience for successful investing: Successful investors embrace uncertainty, practice restraint, and accept not having all the answers. They avoid overconfidence and conservatism, do the least trading, and build well-diversified portfolios.

  Successful investing, especially in the context of trend following or long-term portfolio management, requires overcoming human instincts for immediacy, certainty, and action. Instead, investors must embrace uncertainty, restraint, patience, and the acceptance of not having all the answers. This can be challenging given the constant stream of news and trade recommendations, which often lead to disappointment and poor decision-making. Overconfidence and conservatism are also common biases that can negatively impact investment performance. The most successful investors, according to studies, are often those who do the least trading and have a long-term perspective. As Ray Dalio emphasized, finding truly uncorrelated assets and building a well-diversified portfolio is key to avoiding the need to constantly worry about market fluctuations. In the end, being aware of our own biases and learning to resist them is essential for making sound investment decisions.

• Understanding emotions and biases in investing: Trend following eliminates emotions and biases for optimal investment outcomes. Jeff Bezos and resources like DUN Capital and CME Group's 'Doctor Lindner Revisited' can help.

  Human emotions and biases can significantly impact investment decisions, often leading us to react incorrectly to information. These emotions and biases can cause investors to underreact or overreact, resulting in suboptimal investment outcomes. Trend following, on the other hand, aims to eliminate emotions and biases from investment strategies by following rules and not trying to predict market movements. Jeff Bezos is an example of someone who has successfully leveraged human behavior in business. If you're interested in learning more about trend following, Niels Jensen of DUN Capital recommends checking out their website, duncapital.com, for educational resources. Additionally, Stig Brodersen of 2five zero six suggests reading the CME Group's white paper "Doctor Lindner Revisited" as a starting point for understanding trend following. For a more comprehensive list of resources, including books specifically on trend following, check out the free guide available at toptradersunplugged.com/tip. In summary, understanding and managing emotions and biases is crucial for successful investing. Trend following is an investment strategy that aims to eliminate these biases and make objective, rules-based decisions. By following rules and not trying to predict market movements, trend following can help investors make more informed and rational investment decisions.