Most CTAs that I read about use trend-following strategies. Few use mean-reversion. Why the preference for trend-following, in particular to commodities?
Why CTAs prefer trend-following over mean-reversion?
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Take advantage of gaps, easier to move size over fifteen minutes, don't require precise entries, some markets have more seasonality so they have more trending. If they a good CTA, they are doing a good deal of spreading which takes advantage of much lower margins but still good profits, often taking advantage of seasonality. Currencies trend well over time as do Indexes, and if they knows how to "dance" option plays on either/both side of their position for added gains.
Reversion to the mean is often shorter duration trades which tougher to move big size.
For my own accounts, my longest commodity trade has been 5.5 years, lots of rollovers. Lots of option plays, add on to overall positions. Whereas shorter duration trades often the risk is same as long term trade but R:R is much less on shorter timeframe, so in a way, you risking more to get less. Clients don't care much for wild equity curves if you want to keep them.
Too often reversion to the mean are more like day trading, lots of commissions.
Reversion to the mean is often shorter duration trades which tougher to move big size.
For my own accounts, my longest commodity trade has been 5.5 years, lots of rollovers. Lots of option plays, add on to overall positions. Whereas shorter duration trades often the risk is same as long term trade but R:R is much less on shorter timeframe, so in a way, you risking more to get less. Clients don't care much for wild equity curves if you want to keep them.
Too often reversion to the mean are more like day trading, lots of commissions.
Historical reasons - most investors think CTA's should be trend followers, so stuck in that style box. If you want to do something else, have to call yourself something else (many large CTA's are operating collective funds not managed accounts nowadays anyway, so not strictly "CTA").
Easier to risk manage - exit is the same as if you were doing stop losses.
Trend following gives lower correlation to stock market, and high positive skew - great diversification properties for long only portfolios.
Agree that trends tend to play out over longer time frames, better for CTA's.
I slightly disagree in that reversion to mean is cheaper to execute (passive execution), and few CTA's are moving size "over fifteen minutes"
GAT
Ex PM @ large CTA
True, although I typically do not trade mean reversion it is simply a short term trend in the opposite direction of the longer term trend. Money CAN be made in both directions although I can't seem to do that.
I think many of the big CTAs like Winton and Transtrend use a blend of trend systems and MR systems. At least, looking at their return profiles it seems so because they have managed to produce decent performance from 2009 to now.
Then there are other CTAs who are pure trend followers. These guys have much wilder equity curves with very poor performance during the QE world (post 2008). They are living the 'diversified trend following' dogma from the 1990's. I don't know what kind of investor in their right minds would invest here.
Generally speaking, mean reversion is a bigger component at the more sophisticated firms who look for deviations from fair value, whether it may be price based deviations of a single asset or relative deviation between 2 assets. Or a fundamental reversion where forecast residuals are deviating too rich/cheap.
But while the reversion guys tend to have straighter equity curves (more time near new highs) they have less profit per trade and therefore need to use higher leverage, which can produce sharper drawdowns with sharper recoveries. But with the right risk management this can be minimized.
Then there are other CTAs who are pure trend followers. These guys have much wilder equity curves with very poor performance during the QE world (post 2008). They are living the 'diversified trend following' dogma from the 1990's. I don't know what kind of investor in their right minds would invest here.
Generally speaking, mean reversion is a bigger component at the more sophisticated firms who look for deviations from fair value, whether it may be price based deviations of a single asset or relative deviation between 2 assets. Or a fundamental reversion where forecast residuals are deviating too rich/cheap.
But while the reversion guys tend to have straighter equity curves (more time near new highs) they have less profit per trade and therefore need to use higher leverage, which can produce sharper drawdowns with sharper recoveries. But with the right risk management this can be minimized.
Yes most CTA's have a big slug of carry strategies, which look more like mean reversion in that they buy low sell high. Plus a few other random bits of pieces.
Because that's what many investors, particularly institional investors want. They would rather have lower returns in return for a lower correlation with equities, and more positive skew, plus tail insurance. They don't like style drift.
The fund managers want to have a higher sharpe and earn more fees, and more diversified strategies (because running a pure trend follower requires very little ongoing research and having a bunch of highly paid PHD's hanging around doing nothing is very damaging). Retail investors would also want that. Effectively a multi strategy fund.
The trick is trying to balance out these two competing groups of stakeholders. Or you could launch two or more funds.
eg https://www.ahl.com/programmes/ahl-alpha is closer to pure trend following.
https://www.ahl.com/programmes/ahl-dimension is more multi strat.
GAT
Trend following is easier and has long and proven track record. Mean reversion tends to get chopped up more as picking tops and bottoms is very difficult.
Volatility at historic lows is a pretty good key that trend following is working now while mean reversion is not. That said, intraday trend following has not been doing well which goes to show intraday mean reversion may be gaining traction now.
Mean reversion, when done successfully, is in strong demand. Fund of funds (FoF) need a dispersion of strategies to normalize their returns and like to offset trend following exposure with mean reversion exposure. When trend followers are losing money, mean reversion managers should be making money.
The whole CTA / managed futures space needs more strategies. With the availability of DIY systematic trading tools and a plug and play algo development platforms more traders are turning towards the CTA space to go after that 2 & 20 while it's still around. And yes, there are plenty of emerging managers who are still getting the 2% management complimented with the 20% of profits package.
Volatility at historic lows is a pretty good key that trend following is working now while mean reversion is not. That said, intraday trend following has not been doing well which goes to show intraday mean reversion may be gaining traction now.
Mean reversion, when done successfully, is in strong demand. Fund of funds (FoF) need a dispersion of strategies to normalize their returns and like to offset trend following exposure with mean reversion exposure. When trend followers are losing money, mean reversion managers should be making money.
The whole CTA / managed futures space needs more strategies. With the availability of DIY systematic trading tools and a plug and play algo development platforms more traders are turning towards the CTA space to go after that 2 & 20 while it's still around. And yes, there are plenty of emerging managers who are still getting the 2% management complimented with the 20% of profits package.
I guess the difference usually is that you enter a mean reversion trade by going against the market direction.
Reason funds prefer trend following is that it's scalable while best mean reversal trades happen with limited liquidity.
I am a trendfollower but I noticed that I take most of the time tops and bottoms. All this within the trend. So does that mean that I trade mean reversion in trend?
I am never busy with all these explanations like mean reversion, support/resistance... My native language isn't english. I probably don't even understand what mean reversion exactly means.
I just trade the way I trade. I try to take as much as possible from every move. And avoid losses as much as possible of course.
I am never busy with all these explanations like mean reversion, support/resistance... My native language isn't english. I probably don't even understand what mean reversion exactly means.
I just trade the way I trade. I try to take as much as possible from every move. And avoid losses as much as possible of course.