Wisdom Financial – Trend Following Update – Q1

The trend following environment has certainly cooled off following the exciting moves we saw in 2008 as energies, equities, grains, food and building products all declined sharply. Overall, prices have started to consolidate in 2009 which is evident in the Reuters/Jeffries CRB index.

After a remarkable year of performance for “Managed Futures” and systematic trend followers particularly; some posting returns in the triple digits, 2009 has started off slow for this sector and for several reasons.

First , a rebound in stock and commodity prices have produced counter trend moves which have reduced trading profits in open positions. In many cases the moves were substantial enough to force trend following systems out of the market.

In addition, correlations between commodity prices and stock prices have increased which has made it difficult for diversified trend followers to produce profits in an environment where lowly correlated markets typically provide diversification, reduced risk, and increased opportunity. In the current environment, risk and reward appear to have increased and opportunity has diminished.

Finally, “volatility” risk in markets that have seen substantial moves in 08 has increased due to sharp sell-offs from the all-time highs many commodity markets experienced last year. This “apparent” or “implied” risk affects position sizing for trend following systems and the ability for trend followers to take new positions as their money management strategies are affected.

Heading into the second quarter we’re looking for this consolidation cycle to breakout and provide new trend following opportunities. We’re also looking for some of the correlations between energies, grains, and equities to unwind and would expect greater diversification opportunities to surface.

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