Following The Trend: diversified managed futures trading [PDF]

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Following The Trend: diversified managed futures trading – Book

A common and often very effective method of smoothing returns of a trend-following futures strategy is simply to add a counter-trend strategy to it. Does that sound like a big contradiction in terms? It may seem odd, but this is something that works very well for some of the best trend-following futures managers.

The big money is in following the trends and that is where the main action should always be, but by adding a taste of a shorter-term counter strategy you may achieve equal or even higher returns with lower volatility. A counter-trend strategy has a very different personality to our core strategy. This type of strategy is usually based on taking the opposite side once a market has made an extreme move in either direction, keeping the stops very tight and taking profits early.

Think of the counter strategy as more of a hit-and-run tactic in which you are fighting against the stream, and so once you have a profit you need to take it off the table and wait for the next opportunity. Generally speaking, most counter-trend strategies have a higher hit ratio than their trend-following counterparts.

That means that you win on a higher percentage of the trades you make, but on the other hand, your gains are smaller in relation to your losses than for the trend followers. You rarely see countertrend strategies that stay long with a position. They tend to hit their stops fast and get out or move to their profit targets and get out quite soon after entry.

The desired properties of such a strategy in this context are positive expected returns in combinations with low or negative correlation to the trending strategy. If you can achieve that, you can use it to smooth out the return profile of your core strategy without compromising the potential yield.