You may never have heard of Trend Following as an investment strategy. That’s because it’s not a commonly followed approach for any of the Finance Experts you’ll find out there. It’s an investing approach that has been in existence for a long time but has only been used by hedge funds, until now. My guest on this episode is Alex Krainer, Founder of Krainer Analytics and I-System Trend Following.
He’s served in the financial industry as a hedge fund manager, market analyst, and futures trader since 1996. He’s also the author of many books. He publishes the daily “Trend Compass Report,” which I have found extremely valuable. This episode will introduce you to the concept of Trend Following, explain the basics of how it works, and walk you through Alex’s experience as what might be considered a “contrary” voice in the investing world.
In 1997, Alex worked for an oil trading company and was asked to develop a systematic way to manage market risk. As he assessed the situation, it wasn’t so much a matter of risk as it was a matter of uncertainty and he couldn’t predict the future. For years the company had used the typical Fundamentals analysis approach, which had led them to big losses. As he and his team looked at the problem, they knew that if they could figure out the trends the market operated on and could extract value from those observations, they would be on the right track.
They discovered that many hedge funds were already pursuing a trend following approach and were experiencing great success. He and his team built a prototype of their trend following model in 1999 and discovered many maintenance problems that kept them from optimizing the system. He refined the model in 2000 with the help of a professional software engineer and has been using it without a glitch since that time.
Alex learned much of his investment philosophies from watching a documentary about predators in the wild. As he watched lions going about the act of hunting, he realized that they instinctively follow a predetermined “hunting process.” He reasoned that this process was part of their design and was to ensure that the species’ instincts and decision-making processes were profitable. And he could see that they were profitable or else lions would not continue to exist. His observation was that predators pass most of their time watching potential prey. They take action to go after their prey only when they see the right opportunity.
There is also a risk-management process that prevents the animals from unnecessarily wasting their limited energy. The second a predator determines it is unlikely to make a kill, it will give up. Alex sums up how he thought about this natural process in these words, “If you follow nature’s logic and nature’s model then that would probably be a way to design a system of managing investments that could potentially be infinitely sustainable and infinitely generate profits from investing.”
Most financial experts write about the importance of strategy, discipline, and patience in investing, and Alex embraces those principles as well. But he adds a fourth area of focus in his approach—TRUTH. He explains it this way:
You have to understand how...
