During his recent interview on The Long View Podcast, Wes Gray discussed the investor’s monkey brain. Here’s an excerpt from the interview:
So, again, going back to monkey brain, in normal times, people accept normal risk/return and it climbs this wall of worries, so things grind up high and slow. When things crash, because the brain triggers to safety, everything blows up. Well, to the extent you believe that generally describes risk asset classes, and if you look at all of them over time, outside of a few exceptions, that’s how it is.
Well, any sort of trend model that keeps you invested when things are trending and psychology is good, you’re going to be participating. However, when things get really bad, like when they’re in regimes of below some sort of long-term trend, that’s where the risk of this, let’s just puke everything up, is high, and that’s also the risk of big bear markets.
And so, naturally, a long-term trend rule will avoid that just mathematically, and you get to capture most of the upside of the equity risk premium in any sort of risk asset class, but you’re protected from some of the details in that regime of, oh my God, we might die. So, again, it’s not perfect, and it loses 80% of the time; but again, that 20% of the time that it helps, that obviously saves your bacon.
That’s a long story, and it’s actually much more common with that, but that’s the general idea theory of why I believe that long-term trend-following has worked historically and will probably work for as long as humans are involved in the stock market.
You can listen to the entire discussion here:
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