Simplicity in Trend Following | Andreas Clenow

Episode Overview

• Andreas Clenow champions the philosophy of simplicity in trading systems, arguing that complexity is a liability unless it provides a significant, paid-for advantage.
• The discussion distinguishes between "trend following" in diversified futures markets and "momentum investing" in stocks, highlighting the different rules and risk management required for each.
• Clenow emphasizes that while the rules of a trading system may be simple, the psychological discipline to execute it, especially during long drawdowns, is the most difficult aspect.
• The conversation touches on the practical realities of starting a trading business, including the significant regulatory hurdles and the necessity of building a model based on stable management fees.

Key Concepts

• Simplicity Over Complexity: Simple, robust trading systems are superior to complex ones. Complexity often leads to over-optimization and is harder to execute, so it should only be added if it provides a clear and substantial benefit.
• Trend Following vs. Stock Momentum: A clear distinction is made between trend following, which relies on broad diversification across uncorrelated futures, and stock momentum, which requires specific rules like a market filter to avoid bear markets and generally avoids shorting individual stocks.
• The Power of Diversification: The success of trend following is deeply rooted in trading a wide array of uncorrelated markets; this diversification benefit is lost when applying the strategy to a small or highly correlated set of assets like stocks.
• Simple Rules, Difficult Execution: The rules of a systematic strategy can be straightforward, but the psychological challenge of adhering to the system through inevitable and potentially long drawdowns is what makes successful execution difficult.
• Challenges of Stock Momentum: Trading momentum in equities requires a ranking method to select from thousands of stocks and a market filter to avoid buying in a bear market, as stocks are highly correlated and tend to fall together.
• Practicalities of the Trading Business: Starting a money management firm involves significant and rising regulatory costs, which create a high barrier to entry. A sustainable business must be able to cover all costs from management fees, as performance fees are too unreliable.

Quotes

• At 0:04 - "Why add complexity if you don't get paid for it? You have to get paid a lot to add complexity, otherwise the complexity is not worth having there." - Andreas Clenow explaining his core philosophy on designing trading systems.
• At 29:56 - "On one side you can say easy. The rules themselves are often easy... That's not where the complexity is." - Clenow clarifies that the concept of trend following is simple, but the psychological challenge of executing it is what makes it difficult in practice.
• At 40:27 - "Don't buy stocks in a bear market. You have to have some sort of filter for what is the overall stock market doing." - Clenow states the most important rule for his stock momentum strategy, emphasizing that you cannot expect individual stocks to rise if the overall market is falling.
• At 41:05 - "Shorting stocks is a fool's errand... Most people lose money on shorting stocks. Shorting stocks is very, very difficult." - He explains his reasoning for not shorting individual stocks in his momentum model, citing their violent behavior in bear markets and the risk of takeovers.
• At 49:35 - "All the wrong people know this anyway, so who am I really hiding it from?" - Clenow explains why he is open about sharing his trading models and "secrets," stating that professionals and competitors can already figure it out, so he prefers to be transparent.

Takeaways

• Prioritize simplicity when designing trading systems; added complexity must justify its existence with significantly improved performance.
• Recognize that different asset classes require different strategies; a trend following model for futures cannot be directly applied to stocks without key adjustments, such as a market filter.
• The greatest challenge in systematic trading is not the complexity of the rules but the psychological discipline required to follow them consistently, especially through losing periods.
• Building a viable money management business requires a robust plan to cover high regulatory and operational costs through stable management fees, not volatile performance fees.