A Paradox: Avoid Correlation by Following the Trends
|Apr 2nd, 2012 | Filed under: CTA, Commodities, Institutional Investing, Today's Post | By: cfaille||
A common Wall Street adage runs, “the trend is your friend.” Skeptics sometimes add to that the words, “…until it isn’t.” Commonfund has issued a new white paper that illuminates both sentiments, in the course of contending that futures funds managed by Commodity Trading Advisors (CTAs) can play a valuable part within institutional policy portfolios.
In particular, the authors, from Commonfund’s Hedge Fund Strategies Group, seek to defend managed futures against the charge that they are invidiously opaque, a “black box.” CTAs got their start as vehicles for following trends (“taking positions and letting profits run while cutting losses short” as the white paper puts it) and this still remains their most common model type. This subset of CTAs in particular, then, is much more transparent in their operations then its “discretionary, thematic counterparts.” CTAs are data driven, and the data by which they are driven is available to the rest of the world.
The authors quote Rishi Narang, author of a highly regarded book on quantitative trading, Inside the Black Box (2009). Narang says that trend-following works from the premise that trends represent a process of consensus building. As a new idea takes hold, “the earliest adopters of this idea place their trades in accordance with it” and they get to watch in satisfaction as “a growing mass of market participants adopts the same thesis.” The early adopters, for this purpose, don’t have to be the absolute first adopters, because a price may “take a considerable amount of time” to get to the equilibrium level where the consensus has been fully discounted. Early adopters can surf the wave to the beach.
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Christopher Faille is a Jamesian pragmatist. William James has taught him, for example, that "you can say of a line that it runs east, or you can say that it runs west, and the line per se accepts both descriptions without rebelling at the inconsistency."
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