SI310: The Illusion of Backtests and True Drivers of Price ft. Richard Brennan

16 snips

Aug 24, 2024

Richard Brennan, an expert in volatility and investor behavior, shares insights on the recent market turbulence, comparing it to airplane turbulence as a metaphor for volatility. He argues against the reliance on backtesting for predicting future performance, advocating for more realistic expectations of risk and returns. The conversation highlights how human behavior influences price movements and discusses the role of trend followers in this dynamic. Brennan also addresses the benefits of including highly correlated assets in trend-following portfolios.

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ANECDOTE

August Volatility

High volatility in early August caused market turmoil, impacting trend followers.
However, markets quickly recovered, highlighting their unpredictable nature.

ANECDOTE

Turbulence Analogy

Airplane turbulence, though causing internal damage, never breaks the plane's structure.
Similarly, trend following models remain robust despite market volatility.

ADVICE

Discipline and Trend Following

Respect trend following models and maintain discipline.
Avoid overriding model rules to prevent negative consequences.

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Together with Richard Brennan we address the high level of volatility we have experienced this month and what airplane turbulence can teach us about periods of volatility. We also discuss why backtesting can’t predict future performance and what can be done to achieve achieve more realistic expectations of future risk and returns. We then dive into how investor behaviour drives price movement and how trend followers play a role in this, and why it may still make sense to include highly correlated assets in your trend following portfolio and more.

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Episode TimeStamps:

01:01 - What has been on our radar recently?

04:43 - What can trend followers learn from airplane turbulence?

11:48 - Industry performance update

18:24 - The limitations and pitfalls of relying solely on backtesting

33:42 - Advice for using in- and out-of-sample data

36:31 - How collective trader behaviour influences price movement

48:03 - How cocoa is the perfect example of investor behaviour and price movement

52:47 - Why highly correlated assets may still be beneficial to your portfolio

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