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May 17, 2024

How to better understand stock prices as an IRO

‘Trend-following’ rapidly becoming part of investors’ tool kits

Institutional investors and their investment decision-making processes are evolving to become more data-driven and systematic – that’s using strict rules for portfolio construction.

Discretionary stock and bond picking is becoming increasingly obsolete, being replaced by quantitative analysts or ‘quants’, big datasets and custom-built algorithms that can pick attractive assets much better than human portfolio managers can.

This story of technological change used to apply only to innovative hedge funds, but is now showing up in the activities of traditional ‘long-only’ investment managers, which are increasingly looking to gain an edge in the face of falling fees and aggressive competition from index-tracking vehicles like ETFs.

So how can IROs maintain an edge with the institutional investment community in this new landscape? One way is to begin to look at stock prices in the same way investors and their algorithms do.

‘Trend-following’ is an investment style that is more than a century old and was popularized by journalist Charles Dow in his famous, eponymous theory (he also created the Dow Jones indices). It seeks to mathematically uncover – and then exploit – visible trends in asset prices that occur over time. It’s a highly objective, data-driven investment strategy, upon which opinions or news have little bearing.

IROS need to know about trend-following for two reasons:

  • Because all markets trend. Understanding the status of a price trend in your company stock (or a peer’s stock) is powerful knowledge for an IRO and facilitates effective action
  • Trend-following indicators are substantial inputs into those big, complicated investor trading algorithms I mentioned earlier. In understanding price trends, you will (de facto) better understand how your investors make decisions and what they might do next.

Trend-following is, by all accounts, a truly objective lens for looking at a company’s stock price. What’s great about the method is that it doesn’t require any interpretation of news or company information. It is simply pure mathematics applied to asset prices, and that’s why clever investors like it. Another unique feature is that when used properly, it can counter our human bias or beliefs about how new information will impact stock prices.

For example: imagine that a company releases what its C-suite considers ‘sub-par’ financial results, perhaps in relation to its peer group. After the earnings release, a trend analysis shows the IRO that the stock is still expected to trend positively for months ahead. What a relief!

But should the IRO trust his/her instincts or the trend? We should always trust the visible trend in the marketplace and the mathematics that have exposed it, vetoing our emotional reaction to the news and how we thought it might impact our stock price. This objective reasoning is the power of trend-following and it’s why it works so well for investors around the world.

S&P 500 Index, 2015-2024.

S&P 500 Index, 2015-2024. A trend-following indicator in the lower half of this chart picks out areas of positive trending (green) and negative trending (red). Not all signals are shown

Source: TradingView

For an IRO, gaining access to trend-following equity research can be a significant advantage. For one, expectations about the company’s share price future are made clearer. It’s great if your company share price can be shown to be trending positively over the next six to nine months. You can now relay that knowledge to future (or existing) shareholders with confidence and build new company storylines around this positive price trend.

But what if you’re in the middle of a negative price trend? Well, as the author Aldous Huxley put it: ‘Facts do not cease to exist because they are ignored’. As an IRO, it’s now clear that you have to defend your position and work to reverse the trend. New information, new storylines, new products and reaffirming a strong company balance sheet should all come to the front of any dialogue with investors at this point. Exposing negative trends is not a bug, it’s a feature.

Trend-following research also has the benefit of positively impacting company treasury teams, which can then better understand the trends in currencies, commodities or interest rates that they are working to hedge. And the C-suite can also benefit by being able to talk to stakeholders more confidently about the share price future, and better manage stock options.

In summary, access to a trend-following tool kit adds value to the role of an IRO and enables effective decision-making across the firm. It’s a new way of looking at an old problem.

Adrian Dacruz is CEO and founder of Trend Intelligence, a service offering access to daily, trend-following research reports online