Sunday, April 12, 2015

Trend-following and De-risking



One of the key tactical asset allocation decisions is determining when to get out of markets. This could be called the decision to de-risk. Investors don't usually want to exit markets that have upside volatility but only the downside. Trend-following can provide a simple framework for those who want to cut risk in market exposures. Turned on its head trend-following does not have to be about taking risk but actually mitigating risks.

Trend-following can tell you both what to buy and what to sell regardless of whether you are long/short investor, long only investor, ETF investor, or just stock investors.  It is just learning to employ or interpret how to use the signals generated. In a risky environment, the most important decision may be determining when to get out of trades. Trend-following can do that in a uncertain environment when the fundamentals are unclear.

If the market is moving lower, cut risk by cutting positions. This process does not have to include taking new risks. An exit of one market does not require increasing exposure in other markets. The action could be going to cash.  If more markets are moving lower, there will be less risk taken through delevering. The choice of taking more risk for those markets that are moving higher is separate from the risk-cutting decision.

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