Trend Follow Everything: Bank Woes and Risk Management

As media outlets, governments and markets react to the continuing troubles of Deutsche Bank (NYT, BBC, Bloomberg, Atlantic), our research staff was both eager and curious to examine the potential impact of adding a trend following system to DB’s stock, as well as to those of fellow sector firms Credit Suisse and Citigroup. The recent woes of these companies should come as a surprise to few – consider the following graph of cumulative returns since September of 1997, paying particular attention to the last 3 years:

Past performance does not guarantee future results. 

We did not wish to be prescriptive regarding the type of trend system to use, so we examined 5 separate strategies: 4 moving average systems of varying timeframes and 1 breakout-based system. Decisions were made monthly using daily data. While data was harvested from November 1996 onward, simulation results date since September 1997, given that the moving average-based strategies need a “warm up” period. The strategies were as follows:

1. 50 EMA/200 EMA: own equity when the 50 day EMA is above the 200 day EMA, otherwise move to short-term bonds (VBSIX)
2. 10 EMA/100 EMA: own equity when the 10 day EMA is above the 100 day EMA, otherwise move to VBSIX
3. 10 EMA/150 EMA: own equity when the 10 day EMA is above the 150 day EMA, otherwise move to VBSIX
4. 200 Day Closing Price: own equity when the previous closing price is above the 200 day EMA, otherwise move to VBSIX
5. 100 Day Highs and Lows: own equity when price reaches a 100 day high and sell when price reaches a 100 day low, moving to VBSIX until a new 100 day high is reached 

Statistics summarizing our findings are contained in the chart below. For all 3 companies, buy and hold produced a negative compound annual growth rate (CAGR), a max drawdown of at least -80% and annualized volatility of at least 35%. All 5 trend following systems outperformed buy and hold in every metric for all 3 companies, with trend following producing a positive CAGR in 14 out of 15 cases despite the companies’ poor absolute returns.

Past performance does not guarantee future results. 

The value of $1K for each strategy is displayed in the 3 graphs below:

Past performance does not guarantee future results. 

Past performance does not guarantee future results. 

Past performance does not guarantee future results. 

With buy and hold, investors would have lost money over the last 19 years investing in Deutsche Bank, Credit Suisse or Citigroup. The steep decline in Citi during the 2007 market crash is particularly concerning, especially in light of the fact that an investor who experienced the full extent of the drawdown in Citigroup stock still needs a return of approximately 629% just to get back to breakeven. These crisis situations, while disconcerting for many, serve as a great reminder of the importance of employing a plan which includes cutting losses.