Tuesday, August 2, 2016

Short-term vs Trend-followers - Smooth or rough?

Short-term trading as measured by the SG index has continued to beat the longer-term managed futures SG index. This performance is a difference between smooth and rough trading. Short-term trading can be smoother because it should not be affected by stronger and longer reversals from key news events. The idea behind short-term trading is to exploit dislocations which may only last at most a few days and then move back to cash and await another event. Longer-term trading as often embraced by the trend-following will expect to gain more by market dislocations but also risk more before being stopped-out or reversed. By construction, these managers will be willing to wait on a short-term reversal. The short-term trader should see smoother returns while the longer-term trader will see rougher or more jagged performance.

2016 is a perfect case study of the difference between smooth and rough trading styles. Trend-followers were able to exploit the dislocations in markets during the beginning of the year only to reverse most of those gains when the markets switched to risk-on. Trend-followers were again able to exploit dislocations surrounding the BREXIT vote. Short-term traders made money during the dislocations but turned to more passive behavior with selective trading for the periods of declining volatility. These traders did not have the reversal and kept more of their gains.

What is especially valuable with these two time frame styles is the fact that they will be uncorrelated. A match between short-term and long-term will provide smoother returns overall and diversify trading risks.

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