November 9, 2005

Trend Follower

"The essence of trading comes down to psychological factors. What's really difficult is keeping emotions out of the equation. A completely systematic approach does that automatically...When really big trends happen they can go on for years...The way to beat the market is to have a longer time frame because psychologically participants seem to be too focused on the short term, and the shorter term the action the more chance that it is an aberration - just noise as opposed to true 'trendiness'."

"If you take our initial position and its starts to generate positive returns then we'll increase it. If it starts to hurt the portfolio then we'll reduce it and ultimately exit."

Mulvaney also notes that conventional measures of risk-adjusted returns (i.e. Sharpe ratio) miss the boat:

"Implicitly using the standard devia-tion assumes that the returns are normally distributed. But in fact our returns stream is very positively skewed, and highly asymmetrical. Our standard deviation is extremely high but this is because of the positive outliers. The standard deviation involves squaring the deviations from the mean and the outliers are what really push it up. So a very strong case can be made that CTAs' performance is severely penalised by the Sharpe ratio."