The Complementarity of Trend Following and Relative Sentiment

38 Pages Posted: 17 Oct 2022

See all articles by Raymond Micaletti

Raymond Micaletti

Relative Sentiment Technologies, LLC

Date Written: October 2, 2022

Abstract

We investigate the complementarity of trend following and relative sentiment for equities. On the surface, the unconditional correlation of these strategies (0.69) is moderately high, suggesting little may be gained from combining them in a portfolio. Upon inspection, however, we find that relative sentiment tends to compensate for trend following’s two major weaknesses (namely, staying in the market too long after the market has peaked and staying out of the market too long after the market has bottomed). Likewise, trend following tends to compensate for one of relative sentiment’s main weaknesses—not being fully invested in equities during strong uptrends. As a result, a 50-50 combination of the two improves on the performance of each during their respective weakest periods, has a return distribution with thinner tails, and exhibits a lower tracking error to a hypothetical (perfect-foresight) strategy that consists of the maximum achievable performance from switching between the two strategies.

Keywords: Trend following, relative sentiment, tactical asset allocation, time-series momentum, market timing, wealth management, equities

JEL Classification: G10, G11, G14, G17

Suggested Citation

Micaletti, Raymond, The Complementarity of Trend Following and Relative Sentiment (October 2, 2022). Available at SSRN: https://ssrn.com/abstract=4235609 or http://dx.doi.org/10.2139/ssrn.4235609

Raymond Micaletti (Contact Author)

Relative Sentiment Technologies, LLC ( email )

66 Calle Castejon
Villa Franca 2
Humacao, 00791
Puerto Rico

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