Trend Following: An Exit on the Highway to the Danger Zone

A financial media headline with the word “trend” usually jumps off the page at you when you’re an asset manager, like Blueprint Investment Partners, that attempts to generate alpha through trend following. This happened to me earlier this year when I saw this one: “Why trends are so intoxicating for investors – and dangerous.” I clicked faster than Australian breakdancer Raygun can ignite an Olympics debate (and win the meme competition).

I was quickly relieved to learn that this was not a fabricated hit piece on the practice of trend following. Rather, the article by Julie Hyman was designed to highlight the opportunities and challenges that exist when investors attempt to profitably invest in the securities of new products and services taking the mainstream by storm – think Roblox, Beyond Meat, or Airbnb.

Not only was I relieved, but I was also excited for the chance to connect how this endeavor can be aided by a systematic investment process utilizing trend following.

Trend Following: An Antidote to ‘Check Back With Me In A Few Years’?

As is typically the case with articles like this, the author stops short of a potential solution. (This is a frustration many of us on the Blueprint Investment Partners team have experienced with modern-day news and “resources” … but I digress.)

Hyman’s article frames the issue wonderfully, in my view. Stocks like Roblox, Peloton, and Beyond Meat have enjoyed substantial increases in recent years, only to fall precipitously. On the other hand, Uber and Airbnb, which have not avoided hard times completely, have generally done well and sustained their rising trends.

However, the piece wraps up with two sentences that are pregnant with unhelpfulness: “But for investors, either the trend hits sustainably or it might as well not hit at all. So check back with me in a few years…”.

Allow me to pick up where Hyman left off, as this is where trend following can help.

Applying Trend Following to Individual Stocks

First, let me explain our systematic investing process for choosing individual stocks.

Our approach is not to seek out initial public offerings (IPOs) or even existing companies offering new products. When it comes to single stocks, we take an agnostic approach and apply our rules to well-established baskets of securities, such as indexes. In other words, we start with a large universe of stocks and then let our trend-following rules tell us whether to be invested (or not); we pay no regard for fundamental data, such as revenue growth, expenses, or earnings.

The status of the trend is what tells us whether to buy, but it also gives us guidance about how much capital to deploy and for how long. In this way, we like to talk about trend following as being both art and science:

• Science: Trend following is science in the sense that it applies repeatable rules that attempt to find concrete conclusions, or at least a helpful framework for how to view the investment world.
• Art: It is also art in that the beauty of the exact rules is largely in the eye of the beholder. In other words, different asset managers and financial advisors can end up with different rules that suit their personality, goals, and clients. None of them are necessarily wrong, but what one trend follower might call ugly could be considered Mona Lisa to another.

Applying Trend Following to ‘Trendy’ Stocks

A trend following rule we like to use to illustrate how a systematic investing process can help make decisions about individual equities is a simple system where an asset is:

• Owned or bought when its price is above its 200-day exponential moving average (EMA)
• Maintained at no exposure or sold when the price is below the 200-day EMA

In terms of trend-following systems, it doesn’t get much simpler than this. With that said, we think this simple system does a good job of illustrating the power of trend following:

Roblox: RBLX reached the 200-day mark following its IPO December 21, 2021. Since then, its high price was one week later at $108 per share. January 13, 2022, it fell into a sustained period below its 200-day EMA, with a close at just over $80 per share. The next time RBLX traded above its 200-day EMA was more than a year later, February 2, 2023, at just over $40 per share. Using the simple 200-day EMA trend following rule would likely have improved an investor’s performance by either sidestepping this IPO altogether or triggering an exit prior to the ride down to its current level.

Peloton: PTON reached its 200-day mark after IPO July 13, 2020, at $61 per share. It rose as high as $171 per share in January 2021 before finally falling below the 200-day average March 4, 2021, when it was $104 per share. After a few fits and starts during the next few months, PTON has essentially remained below the 200-day average since September 14, 2021, when it was at $108 per share. Since then, it has spent only a handful of days above its 200-day EMA and currently trades below $5 per share. Ouch. Again, applying the simple 200-day EMA trend-following rule likely would have improved an investor’s decision-making process regarding this holding.

How much pain could have been avoided with a simple trend following strategy that provided clear guidance about if – and when – to buy, as well as if – and when – to sell?

The other side of the coin is this question: How much gain could be experienced with clear direction about when to buy and when to keep maintaining a position? For example:

Uber: UBER crossed its 200-day average on the upside in April 2023 at $31 per share, has held on since, and currently trades around $70 per share.

Next Steps for Financial Advisors

Now, there is a lot more to all these systems than what is described in this short blog. Our goal was not to provide a comprehensive report or recommend a particular security or investing strategy; rather, we simply wanted to use these examples to raise curiosity in a financial advisor’s mind about the potential benefits of trend following. Obviously, much more must be done to appropriately apply these techniques to a client’s portfolio.

In fact, we don’t advise financial advisors attempt these techniques independently. Rather, we suggest finding a partner (hint hint) to help. In our opinion, an advisor’s time is better spent acting like a coach than a player. This is accomplished by collaborating with a partner like Blueprint Investment Partners while communicating with clients and finding ways to keep them on track to reach their goals.

While we agree that “trends” as described in Hyman’s article offer perils, we also believe trend following can offer some answers.

Sourcing for this blog: ICE, RBLX, 3/10/2021 to 5/21/2024; ICE, PTON, 9/26/2019 to 5/21/2024; ICE, UBER, 5/10/2019 to 5/21/2024; Barchart.com, Roblox Corp Cl A (RBLX), 8/20/2024; Barchart.com, Peloton Interactive Inc (PTON), 8/20/2024; and Barchart.com, Uber Technologies Inc (UBER), 8/20/2024