Trend Following. Ritholtz Barry

consider two charts that reflect different periods of Dunn Capital’s trading history but tell the same story about their approach. The first one (Figure 2.2) is a Japanese yen trade from December 1994 to June 1996, where Dunn made a monumental killing.

FIGURE 2.2: Dunn Capital’s Japanese Yen Trade

      Source: Dunn Capital Management

      Nineteen ninety-five was obviously a great year for Dunn Capital. And in 2003 Bill Dunn walked through his trend following homerun with an audience that came away with an invaluable lesson:

      This is 18 months of the Japanese yen and as you can see, it went up and down and there was some significant trends so we should have had an opportunity to make some money and it turns out we did. Because the WMA is a reversal system, it’s always in the market, it’s either long or short, trying to follow and identify the major trends. So while this is the first signal that’s shown on the chart and is long, we obviously must have been short coming in to this big rise. The rise was enough to tell us we should quit being short and start being long and it seemed like a pretty smart thing do and after we saw that big rise up.89

      TABLE 2.2: Monthly Performance Data for Dunn Capital Management WMA Program 1984–2016 (%)

      Dunn Capital is riding the trend up that first big hill of the yen in March 1995. They are making decisions within the context of their mechanical system. Bill Dunn continues: “Then we have significant retracement, which caused a short signal for the WMA program; our model has always incorporated near-term volatility and this volatility as we went long was far less than the volatility that was going on when we went short.”90

      Bill Dunn summarizes the trade: “Now also because the volatility was very high here, this rise was not enough to give us a long signal and as a result, we rode this short position for nearly a year all the way down – where we got a long signal that was wrong and we reversed and went down to short. Now that was a very, very good market for our program, but some markets are not so good.”91

      The confidence in Bill Dunn’s tone and delivery cannot be replicated in print. I feel fortunate to have the original tape.

Be Nimble

      Bill Dunn, with a straight face after riding a trend to great profit, once noted: “The recent volatility in the energy complex has been quite exciting and potentially rewarding for the nimble.”92

      What does Dunn mean by nimble? They mean they are ready to make decisions based on market movement. When an opportunity to get on a potential trend appears, they are prepared. They take the leap. They are nimble when relying on their system; they react to the Japanese yen move with precise rules because they trust their trading plan and risk management.

      The second chart is the British pound (Figure 2.3) where, unlike the Japanese yen, the market proved unfavorable for Dunn Capital. It was a whipsaw market, which is always difficult for trend followers. You can see how they entered and were stopped out; then entered and were stopped out again. Remember, trend following doesn’t predict market direction or duration, it reacts – so small losses are always part of the game. Dunn managed the small losses because the British pound was only a portion of their portfolio. Their yen trade more than made up for losses on the British pound trade, because no matter how uncomfortable others are with that approach, for Dunn, big winners offset small losers in the long run.