Trend Following: Weed Control for Portfolios

A powerful motivator for many parents is a desire to have their children’s upbringing to be better than their own. Better schools, a nicer house, more toys, and better vacations are all things many of us wish for our kids to experience – especially if we didn’t have these things in our own childhood.

And yet, there are many aspects of childhood that become nostalgic as we grow older. Certain things that we either didn’t enjoy or outright despised, we now remember fondly.

An example will help explain. And, perhaps unexpectedly, it offers a valuable lesson about investing.

Weed Early, Weed Often

It isn’t uncommon, in more rural and suburban areas anyway, to have a family garden, or at least a flower bed.

There were many chores children usually loathe growing up, and weeding the garden is usually on that list.

Now almost everyone probably understands this principle, but maintaining a crop by eliminating weeds is vital. Weeds grow quickly and compete with the crop for vital nutrition. Another important characteristic of weeds is that they are much more easily pulled up when they are small. Once they spread, the roots strengthen and they can become entangled in the crop, making removal even more time consuming and annoying. Early and often weed control, while unpleasant in the short term, is essential for a good yield.

Trend Following is a Natural Weed Killer

In our opinion, the hateful weed and its removal provides a valuable tutorial for disciplined portfolio management. Like weeds, the impact of losing positions are much more easily managed when they are young and small. Weed control, like loss control, is more effective when it is done in an unemotional, disciplined manner – early and often.

As losses grow, particularly when an investor allows themselves to be emotionally attached, their roots grow stronger. They can become further entangled in the portfolio, making their elimination more difficult and also more damaging.

One of the potential benefits of systematic trend following, which we use at our firm, is the detached removal or reduction of losing positions. Losses (i.e., weeds) are pulled each month in favor of pouring those resources towards more favorable positions (i.e., crops). The goal is to keep compounding as high as possible so that when the season ends (e.g., retirement), there is plenty stored that can be drawn on when needed.