Tuesday, March 26, 2013

"Learning to Love Investment Bubbles: What if Sir Isaac Newton had been a Trendfollower?"

Paper: Learning to Love Investment Bubbles: What if Sir Isaac Newton had been a Trendfollower? by Mebane Faber.

Investment manias and financial bubbles have likely existed for as long as humans have been involved in financial markets. In this research piece we take a look at some of the more famous market bubbles in history and the extreme volatility and drawdowns they experienced. We then examine a simple trendfollowing approach investors could use to manage their risk. Across twelve market bubbles we find that a trendfollowing system would have improved return while reducing volatility.

3 comments:

The Wife said...

Isn't it something of a tautology that a trendfollowing system will work when there is a prolonged upward movement followed by a prolonged downward movement? I like momentum strategies but the question is whether the costs during choppy slow increases outweigh the savings when an asset drops and then continues downward.

CP said...

See:
http://www.creditbubblestocks.com/search/label/momentum

And especially:
http://www.creditbubblestocks.com/2011/05/good-point-about-value-vs-momentum.html

CP said...

So, yes - you're right that momentum breaks down in choppy markets.

The other problem is that people tend to assume continuous prices when markets are clearly not continuous.