Why Trends Exist?

Long-time listeners of our Systematic Investor podcast series know that we love to dive deep into the nitty-gritty details of Trend Following.

You know – the mechanism of generating entry rules, scaling positions, designing an exit strategy, the whole lot. We have also been quite keen to point out that many investors are overexposed to the traditional 60/40 portfolio and by shunning away from a material allocation to Trend Following, they deprive themselves of the potential benefits of this strategy.

What we rarely do at the podcast, however, is take a step back and ask a simple and yet fundamentally essential question – why does Trend Following work at all? Why does this – at first glance – simple strategy that looks at nothing more but the market price continue to deliver results time and time again?

There are many answers to these questions spanning everything from the way that Trend Following systems are designed all the way through how they embed risk management. But there is also a deeper, more significant, albeit obvious, reason – Trend Following systems are successful because they successfully capture (as the name suggest) market trends.

You see, thousands of pages of economic literature have been devoted to studying the phenomenon that financial and commodity markets tend to produce trends. Nowadays, it is a broadly accepted fact that trends exist and can be taken advantage of (as Trend Following systems do).

But why do trends exist? What is driving the seemingly bizarre observation that when prices increase, there is a higher chance for them to continue doing that rather than retracing back? It has generally been accepted that the reason that trends exist is a combination of market inefficiencies and behavioral biases.

“What type of market inefficiencies and behavioral biases?” – we hear you asking. Well, rather than simply listing them here and condemning this article to become one of the thousands (boring) informational sources, we would like to invite you to tune into this week’s episode of the Systematic Investor podcast series in which Alan Dunne – where we went into great detail of this topic.

As usual, we promise your time will be well spent!