015: Niels Kaastrup-Larsson on Trend Following Strategies and Stock Market Turmoil Ahead
Niels Kaastrup-Larsson is a trend follower with more than 20 years experience in the hedge fund industry, working for some of the largest CTAs or Commodity Trading Advisors in the world, including Chesapeake Capital. Niels co-founded, built and managed three businesses within the alternative investment space, including Rho Asset Management of which he is chairman and CEO.
Niels trades futures markets in a systematic and highly-automated way. He is the founder and host of the popular podcast ‘Top Traders Unplugged’, where he uses his experience and contacts in the industry to deliver insightful, engaging and passionate interviews with the most successful hedge fund managers and traders.
Economic and Finance Themes:
In this interview, Niels mentions and discusses: Trend following, futures markets, gold, anomalies, confirmation bias, efficient market hypothesis, fixed-income securities, treasuries, bonds, the Great Depression, stock market portfolio, diversification, equities, systematic trading, stop-losses, technical analysis.
Jerry Parker of Chesapeake Capital, Michael Lewis and Jack Schwager
- ‘The trend is your friend’.
- ‘KISS – Keep it Simple’.
- ‘Cut your losses, let your profits run’.
- ‘Diversification is so important because markets are very different animals and you’re going to have periods of time where types of markets are trending and easy to trade.’
- Strict Risk Control.
Niels’ Personal Habits:
Niels loves playing football on a Friday evening with a group of friends who all come from diverse backgrounds. It allows him to clear his mind and to think about things other than trading.
In todays world we really need to focus on WHY we do what we do and not just what we do and how we do it – Niels citing Simon Sinek (see recommended books below).
- about trend following and how to spot a trend.
- what is a trend following strategy.
- two ways in which we can take on market risk – one good and the other not so good.
- how emotions can lead to losses.
- why trend followers use computers with built-in trend following rules to make trades.
- why we are more likely to buy a bar of soap that is reduced by 50% in a retail store than buy a stock that has fallen 50%.
- how you should diversify a portfolio.
- how global markets are beginning to diverge which is key for a trend following strategy.
- why Niels believes that global markets will be in turmoil within the next 5 years.
- why Niels believes the economic cycle will turn by October 2015.
- why events will unfold just like 1929.
- if the Swiss and Germans should take back their gold reserves from the United States.
about whether there are job opportunities in the trading industry today.
why the industry has become more scientific.
how to navigate through the noise when markets undergo a process of price discovery.
- why Niels created the Top Traders Unplugged podcast rather than write a book.
- Niels recommendation for a great market data resource.
Niels didn’t know what he wanted to do after High-School, but one thing he did know was that he didn’t want to go to university and try to learn from books. He was much more interested in doing things and being practical is his approach to learning.
A job in a bank seemed a good compromise – Niels would learn by doing and get paid for it!
Niels’ Defining Moment
Niels took a job in a large bank in Denmark straight out of High-School and, during his induction week, he passed by a room full of young people waving their arms and shouting. He found out that they were trading currencies, stocks and bonds. Immediately, Niels knew that after his 2 years of training, that’s what he was going to do. At the age of 19 or 20, Niels began trading Danish government bonds.
Niels began reading international magazines about traders and came across tables of rankings based upon trader performance. These traders were systematic trend followers or Commodity Trading Advisors.
It was intriguing to me to see that these people [trend-followers] could continue to produce extraordinary returns.
Niels searched for and read books on interviews with traders in general and some were rule-based or systematic traders.
Niels got a chance to work with Jerry Parker of Chesapeake Capital who was once part of the well-publicized Turtle Trader experiment, which was run by Richard Dennis and Bill Eckhardt.
“It is the most consistent way of investing your money when you look at it in the very long-run” – Niels Kaastrop-Larsson.
I see people like Jerry Parker and Bill Dunn with thirty or forty years track record still making all-time highs and they’re still going strong, There are not that many discretionary traders doing that. I think that there is something to this methodology.
Trend following comes down to the way we as human beings take on risk. There are two ways that we can do that:
1) a convergent risk-taking style.
2) a divergent risk-taking style.
A convergent risk-taking world is one where you believe that you know where all the risks are and you see the environment as being stable. Therefore, you are willing to bet a large proportion of your assets on a single or few investment themes because you really fell sure that you have it right. When assets go up based on on your expectations, you take your profits quickly as the movement confirms your theory.
On the other hand, when equities fall you still believe that you will be right at the end of the day. So what happens is that you are going to increase your risk and double-up – ‘you double in trouble’. Unfortunately, many investors make their decisions when prices are going against them.
In a convergent world, the profile of a trader is one who makes very small gains because you take your profit quickly. But once in a while you have a devastating loss with huge amounts because you won’t accept you’re wrong.
The equity curve or the returns profile for this trader is quite flat and then spikes downwards where you will lose most, if not all, of your money.
In a divergent risk-taking world, people confess that they don’t know what is going to happen tomorrow. So, the way they play these situations is that they are always unsure what they are going to do and, therefore, their risk-taking is generally small. But since their risks are small, it allows them to take risks in many different opportunities at the same time.
If people here are wrong and, because they feel unsure about their investment from the beginning, they cut there losses quickly just to get out. They didn’t feel good from the beginning and if they continue to lose money then it will feel worse.
When these people are right and their trades are working out for them, then they believe that something is right and they take on a little bit more risk because the movement is going in their favor. They increase their position size.
The equity curve of this trader can be flat or slightly down for some time but then spikes upward where they get a good run and increase their risk at the right time. They make a lot of money with these few investment opportunities.
‘The universe that I came from, the trend-followers or rule-based strategies, use a divergent strategy. We’re not trying to forecast what is going to happen tomorrow, we let the financial media try to that. Instead, we analyse historic price data and when data goes in a certain direction, then we essentially react to that price action’ – Niels Kaastrop-Larsson.
Trend Following Strategies
Trend following is about ‘buying highs and selling lows’, which is the opposite to what most people would think. They buy the lows because they think it’s cheap and sell the highs as it’s more expensive.
Trend followers think completely opposite to the traditional investor.
Trend following strategies are also known as using price breakout methodologies.
If a stock, like Microsoft, was reaching a high, a trend-follower would buy or go long this stock with the belief that it could go higher. If the stock was at the lower end of a price range or band, then you would want to go short the stock.
Moving averages could also be used with the same effect, but their are small differences.
Once you’ve got your entry signal, then you need an exit because if you are wrong, you need to cut your losses. You want to have small losses and big winners.
Many traders lose money because they don’t know when to get out and even if they do, they usually don’t have the discipline to get out. This is why trend followers use computers to do it for them because, emotionally, it is not very easy to take a loss. It’s not very easy to take a profit either, so using rules and putting them into a computer.
‘The rules do not have to be complicated. But it’s the discipline of doing this day-in-day-out, even with 10 losing days in a row, you still keep doing it as you believe in the rules you created’ – Niels Kaastrop-Larsson.
Based on cognitive reasoning, our brains actually work quite opposite to our day-to-day decisions that we make.
A lot of people don’t make money in the stock market despite all the news and advice that they get.
Trading a Diversified Portfolio
If you want others to trade for you then you need:
1) Different managers: Each manager trades different markets,
2) Speed: both short-term, medium-term and long-term periods.
3) Strategies: Then you can go into detail about the strategies.
‘You should certainly allocate to smaller managers who are more nimble, who maybe more innovative because they have more flexibility in their strategy, which the bigger firms don’t have. They can trade markets that the bigger firms can’t do.‘
If you want to trade for yourself you need to:
1) Consider whether you want to trade all markets – commodities and financials or just a few.
2) Know how you’re going to make your investments, not when.
Market Turmoil Expected Soon
‘The problem is going to start in the fixed-income market. It’s the bond market that I worry the most. The whole system has been pumped with liquidity and a lot of bad debt is sitting in places in the system that we probably don’t know about’ –Niels Kaastrop-Larsson.
‘The whole idea of creating a strong and more stable financial structure has back-fired because the banks have not become smaller, they’ve become bigger. So the systemic risk that the authorities wanted to combat back in 2009 has in fact increased’ – Niels Kaastrop-Larsson.
The economic cycle will turn by October 2015 and once they turn, that will have a major effect on the financial markets. Once this happens, the fixed-income markets around the world will burst, so the bubble in sovereign debt will burst.
This means the whole financial sector will get into much more serious problems than before because there is not any central bank in the world that can take interest rates from 5% to zero. The weapons in their armoury is much less. This will spill over to the equity markets, but you could see a steep increase in equity markets before this happens. This is what happened in 1929 before the Great Depression.
We could be in the first depressionary environment since 1929 when we get into 2016, 2017 and 2018. That’s a scary thought but it can create opportunity.
The losers in this will be retail investors who, by their bank and financial advisor, will be advised to buy more bonds or more stocks because that’s where we’ve seen the gains in the last 5 years.
Gold Reserves and The Swiss Referendum
The people of Switzerland made the wrong choice by not demanding that the Swiss National Bank should hold at least 20% of their reserves in gold and by not demanding that gold be returned to Switzerland.
Gold will get its shine back. It will fall a little before going back up.
There are a number of theories about the amount of gold in Fort Knox, with one of them being that there is no longer the amount of gold in the vaults there that we may once believed.
If you had an asset at a time of crisis, wouldn’t you want it at home? Countries should have their gold at home. The Americans told the Germans it would take them 8 years to deliver the gold. So maybe there is some truth about whether the gold is still there or not.
Are There Job Opportunities in Trading Today?
The approach to trading is more scientific now more than ever. Trading firms look for scientists who can work with large volumes of data in order to identify patterns.
You are more likely to get a job in the trading industry if you come from a more academic or scientific approach.
If you trade your own account and have found a system, then it could be a good idea to approach a large firm and tell them of your system and trading history. You should be honest that you do not know of all the answers. That way you could get a position with a firm.
‘90% of assets are managed by 10% of managers, and 10% of assets have to be divided by 90% of managers’
How to Navigate Through the Noise When Markets Undergo a Process of Price Discovery
If you are using moving averages, you have the element of time involved meaning that the moving averages have to turn and cross before you get a signal to either enter or exit a trade.
When it comes to exiting a trade, using moving averages can be dangerous in some ways because if you have a very steep and fast change in trend you could give back a lot of your profit.
A price breakout strategy would allow you to use stop-loss rules that can allow you to move up underneath the trend.
The only thing you should look at is the price. Price is objective. It is probably the only thing we can rely on that in this very second the price of a financial futures market is what it is. Anything you start doing after price is a derivative of price whether it is volatility or something else. I would caution against using too many fancy indicators – KISS – Keep It Simple’
Favorite Internet Resource:
- Commodity Systems Inc. – Market Data and Trading Software “Provides great data in a timely manners and it’s quite inexpensive compared to other providers
Where To Find Niels Kaastrup-Larsson:
- Niels Website: TopTradersUnplugged.com
- On Twitter: @TopTradersLive
- Niels’ Podcast: Top Traders Unplugged
- Niels’ Company: Rho Asset Management