E. Trend Following Models
Paul Mulvaney of Mulvaney Capital provided the following visual models of trend following.
According to Mulvaney, the “hockey stick” diagram (Chart E.1) depicts how classic trend following models generate payouts analogous to long options positions. We know from options theory that the value of an option is dominated by the low probability/large magnitude events. The diagonal line slopes upward to infinity. Trend followers do not predict the extent of price changes but seek to capture large outsize moves over significant periods of time. The horizontal line represents the truncation of risk by stop placement and can be likened to paying a finite premium for an option.
Chart E.1: How Classic Trend Following ...
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