Navigating Bull and Bear Markets Using Trend Following

Episode Summary

Executive Summary: The episode examines trend following in equities as a disciplined, systematic way to reduce drawdowns and volatility, while acknowledging its behavioral and performance trade-offs. Justin and Jack explain different trend methods, why trend has struggled in recent years, and how Valydia’s implementation uses ensemble signals, gradual scaling, and asymmetric re-entry to improve investor adherence and real-world outcomes.

Main Topics: What trend following means in equities (Priority: 5/5): The hosts define trend following as using price-based rules to stay invested during uptrends and move to cash or hedges during downtrends, distinguishing it from multi-asset CTA-style trend strategies. Benefits of trend following (Priority: 5/5): Trend following can reduce maximum drawdowns and portfolio volatility, especially during major bear markets, because it seeks to avoid large declines rather than forecast them. Behavioral and implementation challenges (Priority: 5/5): The biggest drawback is that trend can lag in choppy or fast-rebounding markets, causing investors to underperform buy-and-hold and potentially abandon the strategy. Different trend frameworks (Priority: 4/5): The discussion contrasts moving-average systems such as the 200-day average with time-series momentum approaches based on 12-month returns versus T-bills. Ensemble and partial-allocation design (Priority: 5/5): Valydia describes using multiple trend signals together and scaling exposure rather than fully exiting or fully re-entering, to smooth outcomes and improve stickiness. Asymmetric buy/sell logic and buy-the-dip behavior (Priority: 4/5): The system is designed to sell with more confirmation than it requires to buy back in, and to gradually add exposure as drawdowns deepen, reflecting how investors may actually behave. Current market context and outlook (Priority: 3/5): At the time of recording, most major equity indices were in sell mode, which the hosts use to illustrate how negative current trends are and why Paul Tudor Jones’ comments resonated.

Key Arguments: Trend following is useful because it can lower max drawdowns and volatility without relying on macro forecasting or subjective judgment. A purely binary all-in/all-out trend system is behaviorally difficult to maintain because it can lag badly during quick recoveries and look very different from the market. Fast rebounds after shallow corrections can make trend signals appear wrong even when the long-term concept is sound, which is why recent years have been hard for the strategy. Using an ensemble of trend signals is preferable to betting on one exact indicator because no single signal is reliably best in every regime. Scaling exposure gradually rather than flipping fully in and out can improve investor adherence and reduce the behavioral gap between model return and realized return. An asymmetric approach—harder to sell than to buy back in—tries to preserve long-term equity upside while still protecting against major declines. Trend following is best used as a sleeve alongside buy-and-hold rather than as a 100% portfolio allocation for most investors.

Data Points: S&P 500 max drawdown without trend: about 57% - Approximate peak-to-trough loss cited for a long historical S&P 500 sample from around 1970/1971. S&P 500 max drawdown with trend overlay: 34% - Drawdown cited for the same long historical sample when Valydia’s trend-following system is applied. Trend strategy relative performance, 3-year: 3% behind the market - Jack notes recent 3-year performance of their trend-following system versus the market. Trend strategy relative performance, 5-year: 2% behind the market - Jack notes recent 5-year performance of their trend-following system versus the market. Coverage of trend system: over 50 different asset classes, investment strategies, style and size boxes and ETFs - Justin describes the breadth of trend-following signals tracked on the Valydia website. Major equity indexes in sell mode: all major U.S. and global equity indices mentioned - S&P, Russell 2000, Nasdaq, MSCI developed/emerging, and Dow were all said to be in sell mode. Drawdown trigger example: down 10% to down 40% - Jack explains the gradual reduction of trend exposure as market declines deepen. Exposure at 10% drawdown: 80% trend / 20% no trend - Example of the staged buy-the-dip allocation rule. Exposure at 40% drawdown: 20% trend / 80% no trend - Example of the staged buy-the-dip allocation rule during a severe decline.

Pivotal Quotes: "if there was a strategy that I would want to employ right now, if someone put a gun to my head, I'd say simple trend following strategies. They are not too popular today. They will probably do very well in the next five to ten years." — Paul Tudor Jones (quoted by Justin): Used as the episode’s framing quote for why trend following is timely. "price is truth in investing." — Jack: Explains why trend following relies on market price rather than macro predictions or narratives. "we're not going all in, we're not going all out." — Jack: Describes Valydia’s approach to easing in and out of exposure instead of using a binary switch.

Implications: Listeners should view trend following as a defensive, disciplined tool rather than a standalone silver bullet. The episode suggests blended, partial allocations may be more usable for real investors than pure trend systems, especially amid potentially prolonged volatility.