So bonds are not the solution?

The chart from Nicolas Rabener of Finominal compares the drawdown from bonds versus managed futures. If you ask most investors, they would say that a managed futures fund is riskier, yet when you look at the long history of bonds, it does not look attractive. There can be drawdowns for decades. It is unlikely the 10-year will get out of this drawdown in time in the near future. Of course, it is critical to think about upside and what a bond drawdown means. 

Rationale for trend-following updated

 

The case for trend-following is well established, yet, given the fluctuations in returns during periods without a crisis, it is worth revisiting fundamentals and discussing the rationale for this hedge fund strategy. Meketa, the pension consulting firm, produced a white paper on the topic at the end of the year that provides some new insights. 

One, the dispersion between trend-following fund returns is significant. The difference between the best and worst can be over 25%, and the difference between the 25th and 75th percentile averages around 10%.

 

Two, the difference in dispersion will increase with the extremes in equity returns. When market dislocations are greater, there will be greater dispersion in returns. 

Three,  the Sharpe ratio can be smoothed and increased if an investor chooses a portfolio of managers. It may be hard to say what the right number is, but 4-6 seems to provide the benefits of smoother Sharpe and less dispersion in the return-to-risk trade-off 

Diversification and redundancy with trend-following

 

A core tenet of trend-following is to diversify. Diversify markets and diversify the signals. The diversification of markets is rather simple. Add uncorrelated markets to reduce overall volatility. The trend signal is diversified by adding different lookback periods. While medium lookback horizons usually perform best, research has shown that adding short- and long-term signals diversifies the signal set and reduces volatility.

The paper, “Revisiting the strucuture of trend premia: When diversification hides redundancy,” looks at the trend horizon signal more closely and finds that you can add too many signals. Specifically, if you employ both short- and long-term signals, you will likely render the mid-horizon signals redundant. Do not weight signals equally; use some optimization to balance across horizons. When optimization is employed, the mid-range is not useful, and a barbell approach is better. This is not the conventional wisdom often used when diversifying time horizons. A short horizon helps mitigate drawdowns, and diversifying horizons smooths returns across different regimes. The key issue is determining how many horizons are necessary, given that trend horizons are correlated. However, simple optimization does not seem to add value. The data needs to be examined more closely and manipulated. 

The value from trend-following is in the quintiles

 

The Mann Group provides another simple chart that explains why investors want to hold trend-following managers. We have seen the quantile chart before, but the comparison with global bonds and multi-strat provides more insight. First, we have higher-yielding investors who think they can just hold bonds as a safe asset. Bonds will not help you at the downside extreme. The darling of hedge funds has been multi-strat firms. They will do well in most cases except for the lowest equity quantile. When you need protection wuou will not get it. 

Strategy blend is important. Take a combination of trend and multi-strat, and you will be well served across all states of the equity market. 

New CME margin for silver and gold futures - fixed percentage of notional

The CME has set new margin rules for gold and silver. The CME says this is a procedural change with no significant impact on the margin market, but we think it is a much bigger issue and will eventually affect all markets. Traditionally, margins are set as a dollar value tied to the contract's notional value and volatility. It should cover more than the expected most significant one-day move. The link between VaR and margin in this setting is unclear; there is no direct link, and it is determined by a committee. There is a process, but it is not mechanical, and the underlying assumption is that margins will remain relatively stable over time unless market behavior changes significantly.

The new procedure that went into effect for the gold and silver markets is now based on a percentage of notional value. Hence, if the value of the gold or silver contract increases, there will be a corresponding increase in margin. In a rising market, the longs will have to post more margin on their gains instead of being able to take their notional gains out of the market. In practice, most traders will not take excess cash from their margin account until there is a gain in cash balances. In the case of shorts, when there is a gain in the market, there will be a need to post more money. The average cost of shorting will be higher.

Now, at the end of the month, the CME increased the margin percentage for gold and silver, so the margin required for those contracts needed to be posted again. 

Gold margins rose to 8% of the value of the underlying contract from the current 6% for a non-heightened risk profile, and the heightened risk profile margins increased to 8.8% from the current 6.6%.

Silver margins climbed to 15% from the current 11% for a non-heightened risk profile, while the heightened risk profile margins moved to 16.5% from the current 12.1%. Platinum and palladium futures' margins were also boosted.

Exiting at the wrong time - the key investor mistake

Hat tip to Andrew Breer for highlighting this interesting chart of the Man AHL UCITs fund. Notice that money flows out of the fund on the drawdown, and it does not match when the performance turns around. This has been an age-old issue with CTA, but it also applies to many fund investments. Investors lose money and exit the fund, only to see performance turn around and miss the reversal. This seems odd, especially for managed futures, because trading odds are active and go both long and short. Hence, there can be losses, but positions may be cleared out and new positions established that are opposite to the prior risks taken. 

You are buying a system, not a particular investment. If you exit, it is because you no longer believe the methodology can produce position returns. We have learned that trend and momentum do generate long-term returns; however, there will be periods of underperformance. Investors have either been long-term holders or are willing to actively trade their positions, entering or increasing positions during drawdowns. 

There needs to be more research on the decision-making of investor and why or when they exit investments. 

The impact of tariffs on futures trading

 

In a global world, there should be little difference where a futures contract is traded. There are regulatory differences and legal jurisdictions that may lead to preferences for trading, and some markets will dominate based on liquidity. Still, there should be a single world price based on arbitrage, with differences reflecting only the cost of arbitrage associated with moving the product.

Arbitrage breaks down when there is a tariff threat. Look at the spring period when copper flowed to the US, as investors were copper buyers looking to front-run tariff increases. We can see it in the warehouse receipts. Buy futures, take delivery, hold in approved warehouses, and await the tariff dislocation. This worked until the copper tariff clarification, which allowed prices to return to equilibrium.  This is a clear reason for multiple markets trading different commodities.

We can still learn from Commodities Corp

 

We can still learn from old-school traders who combine fundamental and technical analysis. Do not fight the trend; instead, load up on high-conviction trades.

Hemmut Waymar and Commodities Corp  - Fortune Feb 9,1981 

Over the next few months, the trading team spent many late nights devising a framework of controls that is still in use today. It imposes two principal controls. First, each trader is a profit center. At the beginning of each fiscal year, he is handed a "trading fund," based on his prior year's performance. The system grants the trader a free hand as long as he is making money, but it bears down on him if he starts to slip. If he loses 50% of his initial capital, he must sell off his position and take a month off from trading to write a memo to a management committee explaining what went wrong.

The second control formalizes the sort of guidelines Hostetter had been using for decades. The control is tied to the signals generated by the TCS system. If a trader holds cocoa futures, for example, and TCS detects that prices are headed downward, he is forced to get all but 10% of his capital out of cocoa. If he is authorized to trade several commodities in which TCS sees a downward trend, he has to get all but 20% of his total funds out of those goods. In other words, a trader can put up very little money bucking a trend. TCS has become the traders' watchdog as well as a robotized commodities gambler. TCS's trading record has won over even Samuelson. Today, in fact, the TCS fund manages some of his personal money. 

Traditional versus non-traditional futures markets

 

There has been an ongoing debate within the trend-following community about whether traders should add more markets to their portfolios. Quantica Capital, in its Quarterly Insights #23, September 2025, discusses the value of alternative market trends. There has been an unusual period of high return during the period when many managers extended their set of investment. This provided a strong tailwind for managers who widened their market exposure. More recently, the Sharpe ratios for these investments have fallen relative to traditional asset markets. Hence, there has been a performance drag on the CTAs that widened their exposure. This suggests that managers should reconsider their involvement in these markets. However, the answer is more complex. A strategy with a lower Sharpe ratio may still add value when its correlation with the existing portfolio is low.  

The fundamental thinking about the value added from a given asset is old and well-known, yet has often been forgotten by managers in their search for better returns. The key to trading alternative markets is not just based on backtested returns, but also on the correlation with the existing markets. 

Nevertheless, transaction costs, which include liquidity, must be taken into account. A successful strategy with high returns must account for the costs of trading and liquidity.

European versus American trend-followers

 

A recent paper, "The Science and Practice of Trend-following System", makes the interesting observation that there is a difference between European and American CTAs or trend-followers. The paper tries to provide a unified system for trend-following, a noble cause. However, what piqued my interest was the authors' comment that there were three major trend-following classifications: European, American, and time series momentum. 

I have always believed and commented that there is a difference between the major European and American trend-followers. I have stated that Americans are ideologues who adhere to a system developed in the 70's and 80's, while Europeans are pragmatists who focus on any technique that seems to generate profits. Sepp and Lucic hold the view that European CTA focuses on continually adjusting positions based on current risk, coupled with exponential moving average systems. American trend-followers emerge from the technical system world, focusing on breakout systems that involve full positions based on the signal. The third system focuses on time series momentum systems, which are correlated with moving average crossover systems. 

You might think that these approaches are all the same, but you would be wrong.  The American system has the highest Sharpe ratio, but the other methods are not far behind. In a given year, there will be differences, but it is hard to say that one approach is superior to another. You are left with the issue of finding a strategy that works for your risk tolerance, and in this case, risk tolerance is based on your comfort with the return generation process. 

Riding bubbles is a strategy - but more than one way to do it

Jarrow and Kwok, in their new paper "Riding A Bubble: A Study of Market-timing Trading Strategies," identify when there are Q-bubbles based on local martingale properties. The idea is that a bubble will exhibit extreme values over different time horizons, and an investor should hold a significant bubble move until it reaches a set barrier. At this time, the investor should exit. Ride the bubble until the returns reach an extreme and then walk away. The basic story seems easy enough, yet the key is to determine the bubble component, which is based on the tail probabilities. Bubbles have a fat-tailed Pareto distribution. If an investor sets an upper bound on the price of the asset and it is reached before a certain time, then exit. 

The idea is relatively simple, yet despite the simulations run in the paper, this point of exit is harder to find in practice. It will encourage getting out of positions early, even if there is an optimization and an accounting for risk aversion. 

The trend-follower will generally not follow this type of strategy. The trend-follower will always hold the position until there is a reversal and a stop is hit. You will sacrifice some of the return in exchange for carrying any position as long as possible. Yes, there will be losses in the end when the market turns, but the ability to maintain a position in a bubble will generally be worth the added risk and the likelihood of some give-back. 

Trend-following returns during S&P 500 drawdowns are not all the same

We are learning more about the qualities of trend-following as a hedge or safe asset. A hedge asset is one with low correlation to a risky asset. A safe asset has low correlation overall, but will have a negative correlation during a drawdown for a traditional risky asset. Trend-following will have the characteristics of a safe asset, but only if an extended drawdown exists. If there is a short-term drawdown, it is less likely that trend-following will generate the desired return pattern. This is a key risk of holding a trend-following manager.

There may be some diversification gains, but a safety effect may not exist. We have seen Treasury yields during the current crisis, so it is hard to say whether there is a true safe asset. Therefore, it may make sense to return to first principles. A safe strategy is one that can hold either long or short positions and adjust those positions based on the direction of trends. It is not a structural safe asset but a behavioral safe asset based on the dynamic actions of market participants. 

 

Trend-follower dispersion in return performance

SG Prime Serves has provided their assessment of trend-following managers over the past 25 years since the inception of their index. There is dispersion in performance, which should be expected since there are many variations in trend-following. The trend indicator, a simple trend model for comparison, shows that the correlation between managers and a generic fund will deviate when there is a strong macro event.

The data suggests that holding just one manager may not be optimal and that a portfolio will reduce the potential for regret. Now, is there a correct number of managers to hold? That is a more difficult question. One is too low, yet 6 may be too many if the trend allocation for an overall portfolio is 2%. That said, a large pension may want to include a trend index and then add some satellite managers who have specialized skills. 

 

Words of trading advice from Larry McCarthy

"Higher prices bring out buyers. Lower prices bring out sellers. Size opens eyes. Time kills trades. When they're cryin', you should be buyin'. When they're yellin', you should be sellin'. Takes years for people to learn those basics, if they ever learn them at all."  - Junk bond trader Larry McCarthy.

This is a combination of trend-following and value investing. Higher prices will bring out buyers, which will lead to trends. At the extreme, when there seems to be extremes in sentiment, do the opposite. These are good thoughts to have in mind, yet execution is much harder than you may think.    

Trend-following smiles and frowns basedon time horizons

 

-from Carl Zarattini

Show me the smile. During these times of stress, many investors in trend-following strategies have been looking or banking on the smile associated with this strategy. It has not happened because there is usually a frown in trend-following based on time horizons. A smile using quarterly data will not appear at shorter time horizons. In fact, during short time horizons, there will be underperformance at the extreme. One, extremes may be associated with changes in trends. Two, extremes may cause trend-followers to be stopped out of their positions. Hence, the trend program, which often uses leverage, may have more considerable losses. 

Changing behavior across time horizons is a reality that must be accepted by trend-following investors. 

Holy Grail and trend-following

 

If a trend-following system is too slow, you risk a Type II error by missing a turning point.

If a trend-following system is too fast, you risk a Type I error by reacting to noise.

The Holy Grail of trend following is a dynamic system to adjust speed depending on market/economic conditions.

- from Campbell Harvey Regimes Notes 

I think this is the best way to think about the trend-following problem - a choice between making a type II or type I error. You cannot escape this problem. Reduce type II and you take on more type I risk. Statisticians will often try and to set the type I to 5% and then have a suitable type II at 10-20%. Traders must ask what the cost differences are between type I and type II errors. If you are too fast, you will increase trading costs; if you are too slow, you will miss opportunities. In his regime work, Harvey looks at four states of the world based on observable market regimes, which fits nicely into the idea that trend-following only focuses on price information. The bull market has short-term and long-term returns, both moving higher. A bear market has short and long-term returns moving lower. The rebound has short-term positive returns while long-term returns are negative, and corrections have short-term negative returns versus long-term rates.

His work on regimes shows that return performance can be sorted by these four states, yet further work can be developed to account for other state variables.  

See 

It is all about the market regime or similarity

Momentum and turning points - Working through corrections and rebounds

Managed futures and portfolio construction - A good way of seeing value

The people at 3Fourteen Research of providing good simple analysis for the value of trend-following using modern portfolio with actual performance data. This is not anything new, yet the narrative is compelling. Add managed futures to the classic stock/bond mix and you push out the efficient frontier. No surprise, yet even a 10% allocation will improve the return to risk trade-off. The gain comes from reducing bond exposure and switching to managed futures. 

The expansion of the efficient from trend-following is significant even relative to adding asset to simple stock bond mix. You can expand the asset menu and see an efficient frontier expansion, but if you are looking for more risk reduction, add the trend-following piece. 

We cannot say that the future will be the same as the past, yet these charts reinforce a compelling case for a simple strategy addition. 

 

Trend-following, trading capacity, and diversification

The folks at Quantica Capital have generated a provocative study called, "When trend-following hits capacity: A case study on commodities, exploring the hidden opportunities of limited investment universe diversification". Given the growth in trend-following programs, it is important to think about the issue of capacity. This is once again the age-old question of how many markets should you trade and what is the value of trading more markets. 

Quantica finds that the top ten markets in liquidity represent about 70% of the total available commodity futures liquidity. It is not exactly clear how liquidity is measured but the intuition makes sense. Energy futures dominate commodity futures liquidity along with gold, silver, and soybeans. All the other markets will be harder to trade. This is important because many of the futures that are not in the top ten provide significant diversification. We can measure the value of diversification through a simple measure of the Sharpe ratio is sum of individual Sharpe ratios for each market times the diversification multiplier that is related to the average correlation across markets and the number of markets in the portfolio. There is significant value with moving beyond the top ten markets even though you may not have better trend characteristics and there is less liquidity. Diversification is a benefit unto itself. You pay with lower liquidity, but you get the strongest diversification benefits from commodities. There is no guarantee of higher returns from holding more markets, but you get a strong tailwind from diversification.  

CTA dispersion - Not an issue, now what

Some have argued that trend-followers and CTAs have increased in dispersion because of differences in how to implement their strategies and the markets used. The folks from CFM have developed with some simple charts to suggest that current dispersion is not out of the ordinary. We might be able to say that trend-following is becoming less diverse. 

There is more sameness with managers which has implications on how many CTAs to hold and what to expect from your portfolio. If dispersion is down, then you need fewer managers in this strategy. If there is less dispersion, then there should be a greater focus on cost. Add value through cutting your fund manage expenses. 

Will this continue? As we do more research on portfolio construction and disseminate the information, the same good practices will be past among managers. We should expect more sameness unless there is a new creative thinking.

Below the 200-day moving average - life is different

"Nothing good happens below the 200-day moving average!" maybe attributed to Paul Tudor Jones, but often used.

The asymmetry of markets is strong, and markets will start act differently when prices fall below the long-term average. Is there a theoretical reason for this? No. It is a long-term technical and volatility starts to gain on the downside. This may not be a hard and fast rule, but you cannot go wrong with, at the minimum, using this as a basis for reassessment. There are other rules like the death cross of the 50-day moving average crossing the 200-day moving average. You may not get rich following rules of thumb but having points of reassessment is helpful. Disciplined watchpoints will reduce anxiety.