Trend Following in the Stock Market

Noah Smith highlights some amazing research on investor attitudes and behavior in Does trend-chasing explain financial markets?

He cites 2012 research by Greenwood and Schleifer where these researchers consider correlations between investor expectations, as measured by actual investor surveys, and subsequent investor behavior.

A key graphic is the following:


This graph shows rather amazingly, as Smith points out..when people say they expect stocks to do well, they actually put money into stocks. How do you find out what investor expectations are? – You ask them – then it’s interesting it’s possible to show that for the most part they follow up attitudes with action.

This discussion caught my eye since Sornette and others attribute the emergence of bubbles to momentum investing or trend-following behavior. Sometimes Sornette reduces this to “herding” or mimicry. I think there are simulation models, combining trend investors with others following a market strategy based on “fundamentals”, which exhibit cumulating and collapsing bubbles.

More on that later, when I track all that down.

For the moment, some research put out by AQR Capital Management in Greenwich CT makes big claims for an investment strategy based on trend following –

The most basic trend-following strategy is time series momentum – going long markets with recent positive returns and shorting those with recent negative returns. Time series momentum has been profitable on average since 1985 for nearly all equity index futures, fixed income futures, commodity futures, and currency forwards. The strategy explains the strong performance of Managed Futures funds from the late 1980s, when fund returns and index data first becomes available.

This paragraph references research by Moscowitz and Pederson published in the Journal of Financial Economics – an article called Time Series Momentum.

But more spectacularly, this AQR white paper presents this table of results for a trend-following investment strategy decade-by-decade.


There are caveats to this rather earth-shaking finding, but what it really amounts to for many investors is a recommendation to look into managed futures.

Along those lines there is this video interview, conducted in 2013, with Brian Hurst, one of the authors of the AQR white paper. He reports that recently trending-following investing has run up against “choppy” markets, but holds out hope for the longer term –

At the same time, caveat emptor. Bloomberg reported late last year that a lot of investors plunging into managed futures after the Great Recession of 2008-2009 have been disappointed, in many cases, because of the high, unregulated fees and commissions involved in this type of alternative investment.