Skewness of returns, defined as the asymmetry around the mean, offers a powerful lens through which to understand the behavioural and structural dynamics of different investment strategies. Imagine slowly climbing a staircase, only to take the lift back down. This analogy captures the essence of skewness: frequent small movements in one direction, punctuated by occasional large moves in the other. But the critical question is: is it fact or fiction that trend following is positively skewed?
Trend Following: Positively Skewed by Design?
Trend following strategies are often described as having positive skewness. They typically endure a series of small losses before capturing large gains when trends persist, akin to walking down a staircase and taking the lift back up. This is not accidental. Trend following systems are built to cut losing positions quickly and run winning positions, allowing gains to accumulate while curbing losses promptly.
Crucially, it is only over longer time horizons for return measurement that this behaviour becomes more pronounced. Figure 3 shows how the skewness of trend following increases with the measurement window, highlighting the strategy’s adaptive and self-healing nature: it needs time to react by cutting losing positions or growing and holding winners, so we don’t see positive skewness in the daily returns. It is only over return windows comparable to or longer than the strategy’s reaction time that we observe the strong positive skewness in the return distribution.
Figure 3: Skewness of returns over various time horizons
In contrast, traditional asset classes such as equities have exhibited negative skewness. They deliver frequent small gains, many upward steps, but have proved vulnerable to sharp, outsized losses: the quick lift down.
Skewed Perspective
Despite its favourable statistical profile, positive skewness can be psychologically challenging. According to prospect theory (Kahneman & Tversky, 1979), investors are more sensitive to losses than gains. Frequent and continued small losses can test investor patience and conviction over time, even if they are eventually more than offset by larger but less frequent gains. The challenge is amplified by comparison to traditional assets that seem to ‘win’ more of the time through lots of small gains, until a sharp collective downturn exposes their fragility.
Both evidence and theory suggest it is a fact that trend following returns are positively skewed, but the key is the time horizon. Trend following strategies shine over longer time horizons where their positive skewness becomes evident. By staying the course and understanding the mechanics behind the strategy, investors can benefit from the asymmetric upside that trend following offers.
Insight Paper Disclosures
PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. For Illustrative purposes only. Important performance information, investment risks and legal and regulatory disclosures applicable to Aspect Capital programmes can be found [here].
