The new year opens with a shift hiding in plain sight. As globalization recedes and the world fractures into spheres of influence, Rich argues this isn’t just a political story - it’s a structural shift that favors trend following. In this episode, he challenges the illusion of control baked into most trading systems: why backtests offer comfort, not readiness; why precision breeds fragility; and why the future isn’t something to predict, but something being built in real time. This is a conversation about trading with humility, designing for persistence, and letting go of the need to know. The signal is now.

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Episode TimeStamps:

00:00 - Opening and the start of 2026

03:21 - A fragmented global order and what it means for trend following

08:55 - Why coordination fades and imbalances persist

12:41 - Early market signals and unusual positioning

14:34 - 2025 in review, concentration and recovery

17:36 - Familiar pain and familiar payoffs in trend following

23:00 - Timeframes, diversification, and ensemble thinking

28:37 - Brakes and acceleration, trading the now

40:58 - The future as unfinished, not hidden

49:54 - Prediction versus participation

53:53 - Optimization, comfort, and hidden fragility

01:02:49 - Predetermined response and process control

01:05:30 - Closing reflections and looking ahead

Copyright © 2025 – CMC AG – All Rights Reserved

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You're about to join Niels Kostrup Larson on a raw and honest journey into the world of systematic investing and learn about the most dependable and consistent, yet often overlooked investment strategy.

Welcome to the Systematic Investor Series.

Welcome or welcome back to this week's edition of the Systematic Investor series with Richard Brennan and I, Nils Kasselmarsen, where each week we take the pulse of the global market through the lens rules based investor.

I want to start out by saying a warm welcome.

If today is your first time you're joining us, and if someone who cares about you and your portfolio recommended that you tune into this podcast, I would like to say a big thank you.

Thank you for sharing this episode with your friends and your colleagues.

It really means a lot to us.

Rich, it is wonderful to be back with you in the new year.

How are you doing?

How was your holiday?

A very good holiday, but it's very hot over here.

So large regions of Australia at the moment are in a heat wave, you know, 45 degrees, 46 degrees and into the night, you know, it can be 27 to 30 degrees, so quite uncomfortable in a lot of areas and a few fires about.

But had a good new year.

Probably too many cherries, I think.

And I've just realized that maybe I've got to reduce my intake of cherries.

They're doing bad things to my digestion, digestive system.

But apart from that, it's been a great new year and a great Christmas and happy New Year to you and happy New Year to all our listeners.

Yes, well, happy new to you as well, for sure.

Just going off script a little bit.

You mentioned cherries.

You know what I've noticed?

I do like to watch the Tour de France in the summertime and I've noticed that the bike riders, one of the first thing they do when they finish a long stage, or any stage for that matter, they drink a highly concentrated juice of cherries.

So I think it's good for something, but I'm not entirely sure whether eating the actual cherries is as effective.

I think very good for laxative effects.

Something kills me.

So, yeah, that's certainly what I've experienced.

All right, well, then we've kicked off the new year with some health advice which probably should be taken from any of us, I guess, if people watch one of our videos.

But there we are.

Yeah.

No, of course, this year was, it was a good new year.

But of course, from a Swiss perspective, it was quite a sad new year.

We obviously had a massive tragedy happening over here, three of the people who are the youngsters who who died were actually linked to the school where my kids went.

So very tragic start to the new year.

But of course, that's not why we are here today.

So we'll talk about something different.

We do have a fantastic lineup, if I say so myself, for today.

Thanks very much to you.

But before we get to that, it would be wrong of us not to start with what's been on your radar.

I imagine that there's quite a few things we could mention today.

So I'm very curious to hear what's been on your radar over the holiday period.

Okay, so I've got to mention it because it has been on my radar.

And what it's about is this new emerging new world order towards this geographical separation into spheres of influence, as opposed to the old world order of globalization and what it might mean for trend following specifically now.

That's where the optimism comes in.

I'm not so sure about the other aspects, so I've gotta be a bit careful here.

I'm gonna talk about this from purely a trading perspective.

I'm not making a judgment on whether this new world order is good or bad.

That's a much larger question.

And frankly, the answer depends entirely on where you sit.

So if you're inside one of the major spheres of influence, like the United States, China or Russia, this regionalised world may feel like a return to stability.

Your supply chains are secured, your resources are prioritised, your region looks after its own.

But if you're outside those hemispheres, like if you're in Greenland, for instance, or South American countries, Taiwan or Ukraine, namely smaller nations.

And for instance, over here in Australia, where we're dependent on global trade, we're geographically caught between these spheres of influence.

And that shift looks very different from our perspective looking from outside in.

So it makes us feel, or me feel like having to choose sides.

And it makes me feel a bit more vulnerable than what I felt over the last few years.

So there are real concerns here.

This fragmented world is likely to be less efficient, less cooperative on shared challenges that the world's facing, more prone to conflict.

And these are very serious issues.

But I'll leave that for smarter people to deal with.

I want to talk about the opportunities that this presents to trend following.

And in that respect I'm exceptionally optimistic.

So here's why.

So for a long time, the world felt like it was moving in one direction towards globalization.

Countries traded more with each other.

Supply chains stretched across continents, capital moved very freely, central banks talked to one another and often acted in concert together.

And the big idea then was that integration created stability and the markets therefore reflected that world of globalization.

Sort of inflation moved together, growth cycles all lined up, and when something broke, policymakers from around the world rushed in together to smooth it out.

That was a difficult environment for us trend followers because, you know, these imbalances were quickly absorbed.

Central banks truncated trend moves before they could develop through coordinated intervention, qe, et cetera.

But now that coordination is weakening, countries have become more focused on where power actually sits.

Instead of asking what is good for the global system, governments are now asking what's in it for me?

It's a time where might is right and who holds the cards wins.

Not a time for ethics and old established ties.

So this therefore creates a world made up of regions, not one unified system.

And for trend following, setting aside all the other implications, this shift creates opportunity.

So in the old globalized world, these imbalances were quickly absorbed.

In a regionalized world, however, these release valves, they work much more slowly or not at all.

You know, energy shortages stay regional for longer.

Inflation differs by country.

Currencies reflect local stress, not global averages.

Trade barriers, persistent sanctions last years, not weeks.

Supply chains take time to rebuild.

These are not one day shocks, they are conditions.

And conditions create trends.

So markets don't move because someone predicts the future correctly.

They move because something comes out of balance and stays that way long enough for prices to adjust.

And in this fragmented world, this creates these slow moving imbalances.

And crucially, there's no single authority or coordinated central bank intervention now available to step in and resolve them quickly.

And when something starts moving in this regionalised environment, it's got room to run.

And that's exactly what trend following needs.

Not calm markets, not predictable markets, but markets where pressure builds and persists.

Markets where structural forces play out over months and years rather than getting smoothed away in weeks.

Now, I'm not saying this regionalised world is going to be easy for trend following.

A regionalised world means more political shocks, sharper reversals, periods of chop when regional pressures offset each other.

But the underlying structure favours persistence and persistence is what creates opportunities for our approach.

So, purely from a trend following perspective, I personally think, Niels, we are in a period that suits our strategy probably better than anything we've seen in years.

Yeah, no, I don't disagree with that at all.

I thought that was very well put, of course.

I mean, I think people, regular people who listen to us, they know that I try to keep politics out of this.

And I'm sure people understanding my background and where I'm born will know that I have some strong opinions at the moment.

But if I was going to say, say one maybe potentially funny thing about it is that what's striking is that we all know that President Trump is against the green transition.

So I'm just thinking, why on earth do you want to acquire a country called Greenland?

I mean, that just makes not much sense.

But anyways, we'll leave the politics to those people.

And of course I will say though that on all the other shows we do, we have guests and it's about global macro.

Of course we're going to have politics involved.

That's just how it is.

Anyways, to maybe a few other.

On a lighter note, in terms of things that has hit my radar, one is, I don't know if you follow it, but I saw in the news that a Danish company, very well known worldwide, Lego, has launched its biggest innovation since a long time, 50 years or so.

And that is a smart brick instead of just the usual brick.

So I thought, you know, that's worth a mention.

That doesn't happen that often.

So that's very interesting.

By the way, regarding Legos going AI.

Yeah, you never know.

You never know.

Which wouldn't be good for kids, right?

I mean, I think it's kind of one thing that they did well is to kind of just keep all the digital world away from children by playing Lego, but maybe not so much anymore.

Anyways, the other thing, and this is something we have spoken about on the podcast in other series and when you mentioned the whole globe global politics, I mean the fight for resources that we're seeing.

And clearly that's most likely what's behind what's happened in the last few days in Central America.

That is very relevant, as you rightly say, in trend following.

It's also very relevant if you just look at which of the markets we will talk about this in a second.

That really made the difference in terms of performance.

It certainly wasn't the financial markets last year as such.

So that's interesting.

The other thing I noticed, we look at a world that's changing all the time.

And then yesterday I was looking at YouTube for five minutes and there is this big electronics or innovation conference going on in Las Vegas the first week of January every year called ces.

I mean, all the keyboards, they look like the keyboards we had like 30 years ago.

I don't know if you know those kind of keyboards, but they literally look like.

Which are very popular.

I understand.

I'm not so sure.

They may be smarter than the ones we had 30 years ago.

I just thought it was kind of, you know, what's, what's the innovation here?

But we're going back in time.

Well, you never know.

You never know.

Back to the future.

So the other thing I noticed this is market related and that is that.

And this is not something I would have spotted other than from someone writing about it.

And that is this year is really off to, to setting new records because I think it was yesterday, it could have been the day before.

There was a block trade in the January Fed funds futures of 200,000 contracts in one trade that is by far the largest block trade.

Wow.

Recorded on the CME.

And I think the last biggest one was 84,000 contracts sometime last year.

So 200,000 contracts in one block trade.

That is a hell of a position.

Probably not a classic trend follower.

And you know, but you know, there we are.

Now, before we move on to a little bit of trend following, I want to mention that I just published a couple of days ago the 8th edition of the ultimate guide to the best Investment books ever written.

And it now has more than 600 book titles for people who are interested in finding interesting resources to learn about not just investing, but also other things.

And there's essentially two ways you can get it.

If you already signed up to receive my Sunday emails, you'll get it one way or the other.

But otherwise, just head over to toptradersunplugged.com ultimate and it will take you to an opt in page where you can sign up for it.

I think it's a really valuable resource, otherwise we wouldn't spend time and money creating it.

So I hope it's going to be useful for people out there now.

Did you learn something new?

And what do you think investors perhaps should be taking away from a year like that?

But what held us up, fortunately for the year, was I regard it as a year of concentration.

So there were a small number of persistent trends that did the heavy lifting right throughout the year.

Not all of them, only a small number.

And they were, it was metals dominated.

So the sector, the metal sector for our portfolio, the classic benchmarking portfolio I did that attributed about 21% of total year's performance from metals alone.

And gold was a standout, not through volatility or dramatic moves, but through persistence.

It's been a technically clean trend that's remained intact incredibly the entire year and it's still going.

Silver and platinum also were large contributors, with platinum emerging as a late leader.

That sort of accelerated into year end.

But for US equities, that was modest but positive for us.

Japan led the way with a Nikkei.

The US was mixed for us and actually India's Nifty50 was actually one of the worst performers in our portfolio.

We had these repeated false starts that never developed over the course of the year.

But the main laggards in our portfolio were the currencies, the bonds and energy.

Our currencies dragged on our performance from policy divergence.

The Brazilian real, that started off a beautiful trend, but it had this massive textbook reversal.

So that was nasty for us.

And bonds also dragged on.

The portfolio obviously attributed to this rate uncertainty.

So we had frequent whipsaws in the bonds and energy also lost over the period.

So with crude and natural gas, they failed to develop persistent structure into trends.

So for us, the whole message for the year was concentration and the need to have a diversified portfolio.

And you know, for our particular process, we don't know where the next outlier is going to go.

We don't know if it's going to be broad based or whether it's going to be concentrated or whatever.

But with a diversified portfolio that's sitting there waiting like a trap, whatever the opportunity is, under that level of diversification, you will find that you're riding it.

And hopefully those trends are sufficiently concentrated or enough to do the heavy lifting to pay for all of the losses from the other sectors of the portfolio.

So overall a difficult year.

April, very difficult with Liberation Day, that was our worst drawdown historically we've had for our particular approach.

But from that period on, fortunately we had the metals that recovered us.

I would add a few things to it.

So in one way I think most people would agree that.

And then maybe we're going to be saying this every year going forward for the next, as we go through the fourth turning, let me add that, but that every year is a really unusual year and we didn't see this coming and so on and so forth.

But at the same time, I think that for trend following, for a strategy like ours, it was also a very familiar year and you already touched on it.

But I want to make it absolutely clear what I mean by that is that to a large extent we had many relatively small losses, but we have, as you say, concentration and a few big winners.

That's classic trend following.

That is, that is how trend following works.

So there's very, it's a very familiar distribution of returns when you look at that.

I also think when you, and this goes back to your initial point about your excitement, not about the transition into this deglobalized world, but the excitement for from a trend following perspective.

I mean, I cannot fathom why people can't, won't appreciate the fact that if you have such an unusual, uncertainty, unpredictable world, wouldn't it be nice to have a strategy in the portfolio that does not rely on prediction?

I mean, I think it just makes so, so much common sense.

And I think trend following proved that point.

Let's, let's remember that at the end of June, the SG Trend Index touched its worst drawdown ever in the 25 years of history.

And there was a lot of writing back then, you know, once again calling for the death of trend following and all of that stuff.

But as you know, in fairness, it had touched its worst drawdown or just shy of its worst drawdown in the last 25 years.

But then, and this may not be for the index, I have to clarify, but at least on our side in our program, we had six, we've had six monthly consecutive positive returns since then.

So what looked like a really awful, difficult period has been replaced by an unusually positive period.

Not necessarily in terms of total returns.

We've certainly seen better six month periods like that.

But the consistency and the rotation of where these opportunities came from.

One month it was being short JGBs, one month it was being long gold, the next month long silver, and so on and so forth.

There were, you know, interesting, exciting opportunities.

And then, as you rightly say, it also proved another point which is so important about trend following, which I think sometimes, unfortunately our Industry has, has, has not ignored but de emphasized that is this point about true diversification if you were too concentrated in the liquid markets because you want to manage 10, $15 billion.

So it would have been much more difficult than if you were trading 2 or 3 or $4 billion in a fully, truly diversified portfolio including all the commodities.

So again, the value of commodities showed up as we're not surprised about but sometimes we need that reminder to see that.

And then I also think that you could describe the two halves of the year where you would say the first half was testing our patience as investors.

Right.

So we're rules based but so we try to be super patient with our systems.

And then the second half it was all rewarded, right.

That was just, you know, the systems were ready.

They didn't get fatigued just by having five difficult months from February through June.

So they were ready to, you know, seize the opportunity when it arose.

Even though the overall result is not going to be stunning, right?

It's not going to be stunning.

But in a year where, yeah, where you could say it was certainly challenging for rules based investors coming out with a small positive return, it's not a bad thing.

And also, and again, I have to just look at our own returns here so I'm going to be careful not to, to state them specifically.

But I did notice that for example for a rolling five year period, our returns are very close to our long term average of say the last 41 years since 84 when the strategy was was rebranded.

But we have delivered that average double digit return with a correlation to the S and P of 0.15.

And I'm thinking what's not to like?

The S and P has been on a tear.

So you get lots of returns from your equity portfolio but on top of that you get a boost from your trend following with negative correlation.

And so as you say, I'm excited about that setup for the future and I also think that a lot of investors will be considering how much longer and I'm not predicting that we're going to see that this bull market in equities will stop.

This can continue as far as I'm concerned for many years to come.

But I think there will be people who, who may be thinking about taking a little bit off the table because of the success that they've had in the equity portfolio or because of the concentration risk we have now in equity in indices like MSCI where it's like 70% US equities and then when you drill down it's like seven equities.

You know that is really behind that.

So anyways, very interesting takeaways from what looks like an unexciting year if you just look at the annual return.

That's a strong start so far and I think that goes well with the initial numbers.

We see beta 50 and this would be as of Tuesday up about 2% for the year as far as I can tell, maybe a little bit lower actually now that I think about it the SG CTA index is also up about 1.5 1.6% as is the trend index, Short Term Traders index obviously a little bit less than that.

Also given its lower volatility, that is probably the one thing if, you know, since we are trying to also be a little bit objective about the CTA space, I think there might be some questions about short term trend following following last year because it was a year where you would think that short term strategies would have maybe a little bit of a benefit because there were so many surprises.

It didn't turn out that way.

In fact it was a pretty difficult year for short, for the Short Term Traders index down about 5% or so last year.

And this is something you and I and and, and, and and all the, the, the trend following friends we have talk about and we compare these strategies when I look kind of on internal data on our side and just taking the same market universe, the same model but just adjusting it for time frame or look back period.

No doubt that a short term timeframe say 20 day would have been hit the hardest last year.

Having said that, had you had 60 day look back you would have had a small positive.

This is obviously based on simulation, so don't take it for more than that.

Just to show you the relative importance of timeframe last year.

So around 60 days would have been a small positive.

130 days going further out would have been almost as bad as 20 day look back which is interesting.

A 260 day look back would have been a little bit better but still negative.

So it just goes to show that look back periods is very, very important and in this case at least we're doing it on the same universe of market.

So there is some comparison to maybe be taken away from it with a massive grain of salt of course.

Anything you want to add before we move on?

Well probably that gives a reason to perhaps consider ensemble models that bring in the different time frames together.

Because whilst you might not get the best performer, you'll probably get a better average than trying to be selective in one of them.

Which, you know, there might be a lot of luck in there as well.

Yeah.

So I like your approach to that.

Having diversification in terms of models and not just time frame and markets and all that stuff.

I really do.

All right, Rich, you've.

You brought something a little different to our conversation today.

So rather than discussing specific, specific strategies or market conditions, you want to explore something more foundational, if I can put it that way.

How traders think about uncertainty and why getting that wrong leads to a lot of fragility, even in quote unquote sophisticated systems.

Now you've structured this around three connected ideas.

The first one is behavioral.

So how we actually trade moment to moment and why optimizing for averages falls in or fails, I should say in markets that reveal themselves sequentially.

You got the lovely raising analogy that we all love from Dave Dredge to talk about.

The second one is structural.

So a deeper question about what the future actually is.

Not hidden that you've suggested, but it's unfinished, which is a very intriguing distinction and I definitely want to understand that a little bit better and how we design systems for that.

And then the third one is psychological.

Why intelligent traders keep building fragility while believing that they're building robustness.

Why we optimize for comfort rather than for convexity.

And across all of these three you are arguing that real control comes from not predicting, no optimization, but from pre determined response.

So rules essentially trading the present rather than forecasting the future.

Obviously something that we all are very much behind.

So anyways Rich, let's get into it.

Where do you want to start?

Well, that was a great intro, Neil, so it saved me a lot of time in explaining things.

So these three topics I will be discussing, they're all linked, but let's step through them one at a time and I'll pause after each topic, give you a chance to respond and then hopefully we'll get a conclusion out of all of this.

So I'm going to start with this simple analogy from Dave Dredge that help crystallize this for me from his thoughts about convexity and namely the need for brakes and acceleration to trade the now.

So I know Jim discussed this in our Christmas get together, but I'd like to extend this thought today.

So a Formula one race is not won by driving at the average speed of the track.

This sounds obvious.

In motorsports, no driver tries to maintain the average lap Speed at all times.

They slow aggressively into corners and they accelerate fully on straights.

They adapt continuously to what is in front of them.

So the whole sport of motorsport is about responsive variation, not consistent averaging.

But in markets, traders do something different.

They study the past.

They calculate what worked on average, and then they try to reproduce that average behavior in a future that has not yet revealed itself.

So let's think about what this actually means.

So they find the historical optimal allocation, the average volatility, for instance, the typical drawdown, and then they size positions to match that historical pattern.

The problem here is not ignorance, as many are often very smart people.

But the problem is misapplied certainty.

And backtests play a big role in this.

So a backtest gives you the entire track, every corner, every straight, every outcome is visible from your backtest.

The track feels finished.

That sense of completion is deeply comforting.

It quietly suggests that correct speed exists and that with enough refinement, we can discover it and you can see the entire journey from start to finish.

With a backtest, you know where the drawdowns occurred.

You know when the trends ran.

You know exactly how long to hold on and when to exit.

Everything is resolved in a backtest.

But real markets are not like that.

Markets are disclosed sequentially, one section at a time.

You don't see the corner until you are approaching it.

You don't know how long the straight will run until it ends.

And when you trade as if the track is complete at an average speed based on the past, you overspeed the corners and you lift the foot or decelerate to slow down on the straights to keep that average speed.

So let's be specific about what I mean by that.

So risk gets sized for historical calm.

So sharp corners arrive too fast if they're not observed in the backtest.

A position that looks reasonable based on average volatility on the past becomes catastrophic when volatility in the future spikes.

The trader sized for the backtest.

They didn't size for the corner that they're actually in.

So profits get capped because results feel good enough.

It's like the backtest so long, you know, these long straights, they're typically abandoned early.

A trend that has further to run gets exited because it has already exceeded what the back test suggested was normal.

The trader lifts their foot off the accelerator precisely when conditions favour pressing actually harder.

And when they rely on the backtest to gauge the future, that the assumption is that history is going to continue on in the future.

Smoothness replaces responsiveness, acting in the now.

Average exposure replaces what I call situational response.

And what feels conservative is actually careless.

So I want to be clear here.

I'm not criticizing backtesting as a tool, because backtesting is essential for understanding how systems behave.

But the error is treating the backtest as a map of the future, rather than what it is, which is a study of the past.

So this is where brakes and acceleration matter.

They are situational, they're not relying on a backtest.

Breaks are not predictions, they're commitments.

They exist before the corners appear.

They define how much damage is acceptable when conditions deteriorate.

So a stop loss is a break.

Position limits are brakes.

Drawdown rules are brakes.

You don't decide on the brake.

When the corner arrives, that's too late.

The brake is designed in advance, tested and trusted.

And when the corner comes, the brake engages without debate.

And acceleration.

That's not bravado, it's permission.

It's permission to remain exposed when the structure persists, even when outcomes feel extreme or uncomfortable.

So a trend that has run for months may feel overextended.

Profits may feel too large.

The temptation is to take the gain, reduce exposure, normalize the situation.

But if the structure persists, that's the now.

What is it doing now?

If the trend is still intact, if volatility remains contained, if the evidence supports continuation, acceleration means staying on.

It means allowing the straight to unfold without lifting your foot and decelerating and slowing down to the average.

So together, brakes and acceleration allow the trader to engage with what exists now, not what used to exist.

This is not intuition, it's design, expressed through response.

So the race car driver does not guess how hard to brake.

They've practised that they have a system.

And when the corner arrives, they execute.

When the straight opens, they accelerate.

So I'll turn this into trend following speak.

Imagine a trend follower who enters a long position in crude oil.

The trend's established.

The entry's clean position, size is set according to the system rules.

Then crude oil begins to run.

The trend accelerates and within weeks the position is up significantly, far more than the backtest average suggested was typical.

Now, the trader who sized for average faces a dilemma.

In this situation, this profit exceeds the historical norm.

It feels like a gift.

The temptation is overwhelming to take it, to lock it in, to normalise.

But the trader, who understands sequential disclosure, asks a different question.

They say, what exists now?

The trend's still intact.

Volatility has not spiked in a way that suggests exhaustion.

The system has not signaled an exit.

The structure persists.

So the trader stays on, they accelerate, they allow the straight to continue.

And weeks later, crude oil reverses, the trend ends, the exits trigger.

The profit is smaller than the peak.

We're used to that.

But larger than it would have been had the trailer lifted early or slowed down early.

And more importantly, the trader's process remained in of front intact.

They didn't override.

They did not second guess.

They responded to what existed section by section.

And this is what trading the now actually looks like.

The trader who operates this way stop asking what the historical average suggests.

They ask instead, what exists now and what does my system prescribe?

So that's the first topic I'd like to land on before I move on.

Any thoughts?

Yeah, no, absolutely.

So the backtest giving you the entire track, that's a very powerful image.

But here's what I'm wondering.

How do you distinguish between prudent risk management, if I can call it that, and what you're calling kind of lifting or breaking on the straights?

Where's the line between discipline and maybe premature exits?

Well, the distinction really arises from whether the decision comes from the system or what you're feeling.

So prudent risk management, I believe that is.

It's predefined.

It's like preventative risk management.

It's predefined with the rules that you deploy and you observe and you act on.

So you know the rules before the trade, what conditions will trigger an exit.

When those conditions arrive, you act.

That's discipline according to the rules you set.

But lifting on the straights, that's reactive to comfort, not to condition.

So the system hasn't signaled an exit.

Nothing structural has changed.

But the profit feels large or the duration feels long or the move feels overextended.

And that's why you exit.

That's an emotional decision.

So the test is simple.

So can you articulate the rule that triggered the exit?

If it's a rule you would have written before the trade, I believe that is risk management.

But if you're inventing the justification after the discomfort arose, that's lifting.

So one is process and the other is rationalized emotion, if you know what I mean.

That's the distinction.

Risk management is all preventative enforce before you actually take to the track in the first place.

Okay, cool.

All right.

You're also describing something that I think both of us have seen many times.

You have traders who size for the average and then they get caught out, you could say, when volatility spikes.

So I'm just wondering if there is a counter Argument here where some would say that sizing conservatively for all conditions is in itself a form of break.

How would you respond to that?

Well, it is a form of break, but it's a break that's always on, if you know what I mean.

So if you size so conservatively that no market condition can hurt you, you've also sized so conservatively that no market condition can help you.

So you've removed the downside, but you've also removed the upside opportunity.

So that's not responsive.

That's just small, in my opinion.

So this is where the race car analogy matters.

So the driver who goes slowly through every section, they're sizing down as small as they can go, they go slowly through every section.

They will finish the race, but they won't win.

They've chosen permanent safety over situational response.

So the better approach, I believe, is variable braking.

So size for what you can lose if conditions deteriorate, but allow full exposure when structure supports it.

So that way the brake is there when you need it, but you're not driving with it permanently engaged.

So conservative sizing for all conditions, that is a choice, and it's a valid choice for some traders, but it's not the same thing as having brakes.

It's.

It's the choice, really, to never accelerate.

Cool.

Good stuff.

All right, let's move on to the more kind of structural part and, you know, and the nature of the future, so to speak.

What it really is, what it's really all about.

This is interesting.

I'll be interested in your views on this.

So we've looked at behavior with our brakes and accelerators that trade the now.

So now let's look at structure.

So what we find is that the future arises from what I'm calling sequential disclosure, not revelation.

And what I mean is the future arrives one section at a time as you're going around the racetrack.

So if markets do reveal themselves one section at a time, that raises a deeper question.

What kind of thing is the future?

And that might sound philosophical, but it's got very practical consequences for how we trade.

So most traders carry an unspoken mental model in their minds.

They imagine the future already exists.

It's fully formed, but it's hidden.

It's like a landscape covered in fog.

So the job of the trader in their model is therefore to see further into it.

Better data, better models, better analysis, peer through the fog, gain an edge by seeing what others cannot.

And that's where prediction becomes an act of revelation.

And this model, it does feel natural to us.

It matches how we think about most problems.

If I'm driving in fog, the road ahead of me still exists.

The corners are already there, the surface conditions are already set.

I just can't see them yet.

The fog is an obstacle.

But if you remove the fog or peer through it somehow, then the truth reveals itself.

That's one way of thinking of the future.

But there's another way to understand uncertainty.

And it changes everything.

In the second view, which is the view I support, the future is not hidden, it is unfinished.

So it does not yet exist as a complete object.

So prices are formed through interaction.

Decisions propagate through feedback.

Outcome depends on responses to events that have not yet occurred and choices that have not yet been made.

Nothing is waiting behind the fog.

That's not mysticism.

It's a structural observation about how complex adaptive systems work.

Markets are not mechanical systems, we following fixed laws.

They're ecosystems of decision makers, each responding to each other, each contributing to the structure that emerges.

The price you see today is not a reading from a pre existing reality.

It's the current output of an ongoing process.

So as the process continues, tomorrow's price will depend on today's decisions, on how participants react to today's price, on news interpretations and responses that do not yet exist.

So this matters because prediction in the former method assumes its object, the future, exists.

So they're thinking of it like a physics problem.

You can predict the trajectory of a projectile because the laws governing it are fixed and independent of your beliefs.

You know, the cannonball does not care what you think.

Gravity does not adjust based on your expectations.

But markets are not like that.

You're not forecasting a passive system.

You are engaging with a system that reacts to being observed and acted upon.

The market is reflexive.

So if enough traders predict a price rise, they might buy and cause the rise.

If enough traders predict a crash, they may sell and cause the crash.

The prediction influences the outcome.

The forecast shapes the future it was meant to reveal in the first place.

So this is not a minor complication.

It's a fundamental difference in the nature of what you're dealing with.

So we when prediction fails in markets, it's not just because the data is noisy or incomplete.

It fails because the thing you are trying to predict is still being constructed.

You're not failing to see the future.

You're trying to see something that does not yet exist.

And once you see this, a lot of things click into place.

This is why forecasts do not converge.

On the other hand, in physics, better models produce more consistent Predictions in markets.

However, more traders using the same model make that model fail.

Mean reversion systems, for example, cannibalise a signal over time, as they are negative feedback processes.

So it allows us to answer the question why more sophisticated models often increase fragility.

You see, the more precisely you try and fit a model to historical data, the more assumptions you embed about conditions remaining similar.

But when conditions shift, and in an adaptive system, they always shift, the precision therefore becomes a liability.

So in a future that is not final, it also explains why responsiveness beats foresight.

If the future is unfinished, the advantage goes not to the trader who sees further, but to the trader who responds faster and more appropriately to what actually emerges.

So it also answers the question why trading?

The present is not a technique, but a recognition of where reality actually lives.

The present is not a waypoint on the way to a foregone future.

It's where the future is being built.

Every trade, every decision, every piece of information is a contribution to an emerging structure.

And this connects to my favorite subject, niels, which is the concept of emergence in complex adaptive systems.

So in complex systems, global behavior emerges from local interactions.

So the flock moves, but no bird is directing it.

The market trends, but no participant is controlling it.

The pattern exists, but it was not designed.

The emergence is not chaos.

It has structure, it's got regularity.

Trends persist, volatility, clusters, patterns appear and reappear, but the structure is not pre existing, it is waiting to be discovered.

It's continuously generated through interaction in the now.

So this is why trend following works.

Not because we predict where markets will go, but because we participate in structures as they form.

We align with emergence rather than trying to anticipate it.

The trend is not a forecast, it's a recognition of structure that currently exists.

And the trend follower, they're not predicting continuation, they're participating in persistence.

Or while it does persist and they exit it when it ends.

This is fundamentally a different posture than prediction.

It is engagement with what is, rather than speculation about what will be.

So the trader who grasps this stops asking what will happen and they start asking what is happening and what my system prescribes in response.

So the shift from prediction to response is from revelation to engagement.

This changes everything about how you design systems and how you experience trading.

So that's the second thought, and I think that's a powerful one.

Oh, it's super powerful, actually.

And this whole distinction between hidden and unfinished is very, very.

Well, it's logical in one way, but I want to dig a little Bit deeper.

So I want to make sure I fully understand.

And also the people listening, of course.

So are you saying that prediction is always pointless or that it's pointless in a specific way?

Because clearly you could say that some things about the markets are predictable, such as trends do persist.

We know that volatility does cluster.

So can you clarify that a little bit?

So prediction is futile in a specific way.

And understanding that specificity, I think is pretty crucial.

So you're right that some things persist, trends persist, volatility clusters, momentum exists.

These are statistical regularities and they're real.

But there's a difference between recognizing persistence and predicting outcomes.

When I say the future is unfinished, I'm not saying markets are random.

I'm saying the specific path or the exact sequence of prices, the magnitude of moves, the timing of reversals, that's not predetermined.

It's being constructed through interaction.

So trend following doesn't predict that a trend will continue.

It recognizes that a trend currently exists and positions accordingly.

If the trend persists, the position profits.

If it reverses, the position exits.

That's what a trend follower does.

That's not prediction, that's participation in structure.

So the futility is in trying to know in advance what can't be known.

The specific future, the opportunity is responding to what can be observed, or the present structure.

Got it.

Now, I was also thinking while you were talking about our listeners, we are very, very fortunate actually, as a podcast, to have some really, really smart people among our listenership.

Some of them obviously also guests on the show.

And they will have, maybe we can call it like a forecasting background.

So they might be macro traders, they may be economist, there may be fundamental analysts, you know, you name it.

So are you essentially saying that their entire framework rests on a category error, so to speak?

How do you suggest?

Maybe I'm a bit politer than that, Neil.

So what I'd suggest, I suggest that they think about forecasters hypotheses rather than predictions.

So a macro view, as we all know, is valuable.

So understanding the forces on markets, central bank policy, economic conditions, all of what I've listened to you on the macro series, you know, it's fantastic stuff.

It gives you context, it helps you interpret what you're seeing.

But I believe the error is treating the forecast as the trade.

So if the forecast says I expect inflation to remain elevated, therefore bonds should sell off, the trade shouldn't be short bonds, because my forecast says so.

The trade should be if bonds begin to sell in a way consistent with my hypothesis.

Align with that move.

If they don't, my hypothesis may be wrong or the timing may be wrong.

And I should wait.

So this preserves the value of fundamental analysis while respecting the unfinished nature of the future.

So your analysis gives you a lens.

The market gives you confirmation or denial.

You trade the confirmation, not the lens.

So the hard part is accepting that your well reasoned forecast might simply be early or wrong or right, but overwhelmed by other forces.

The market is the final arbiter, not your analysis.

That's what I'm saying.

All right, well, as we said in the beginning, there are actually three parts to this framework.

So I'm super excited to talk about the last one because that is something that may be, I wouldn't say the hardest one, but anything to do with psychology is something that we all struggle with in so many levels in our lives.

So take us into kind of part three of this.

Okay, Neil, so now comes the uncomfortable part.

So what I'm saying is, if prediction fails structurally, as I did in topic one, and the future is incomplete, what I did in topic two, why do smart traders keep returning to optimization?

So why do we keep tightening systems, refining parameters, smoothing outcomes?

The answer's not stupidity.

Many of the traders who optimize most aggressively are exceptionally intelligent people and mathematically sophisticated.

I'm saying the answer is emotional.

And understanding this emotional pull is essential because without understanding it, you keep falling back into the same pattern.

So an optimized system, like a backtest, an optimized system feels finished.

Every parameter has a justification.

Every weakness appears addressed.

The messiness of uncertainty is replaced by the satisfaction of completion.

In a highly optimized world, the feeling is powerful.

It quiets anxiety, it restores confidence.

It produces a sense of mastery.

And when you look at an optimized backtest with a smooth equity curve, minimal drawdown, precise entries and exits, you feel like you've solved something.

You feel prepared and you feel ready.

But this completion is emotional, not structural.

So uncertainty has not been removed.

Only the feeling of uncertainty has been removed.

And this is how fragility hides inside robustness.

So every refinement that you make to your strategy improve embeds an assumption that tomorrow will resemble yesterday closely enough for today's solution to remain valid.

Those assumptions are rarely explicitly stated.

They're usually smuggled in through calibration.

But when you optimise a moving average length, for instance, you assume that the optimal length from the past will remain optimal.

And when you fit a volatility target, you assume volatility regimes will repeat.

And when you Design entries for specific patterns.

You assume those patterns will persist.

But none of these assumptions is unreasonable in isolation.

But the problem is in accumulation.

Stack enough assumptions together and you're no longer building a robust system.

You're building a system that only works in a narrow band of conditions, conditions that happen to match the historical period you optimized against.

And when they break, they don't fail gently.

They fail all at once.

And this is the cliff to negative skew hiding beneath the smooth surface.

So you see this most clearly in how traders handle gains.

For example, large profits feel uncomfortable.

They arrive faster than expected.

They exceed what feels reasonable.

So they're taken not because risk has increased, but because discomfort has.

So let's think about what's happening psychologically in that moment.

The trader has a position that's working.

The trend's intact.

Their system hasn't signaled an exit.

Nothing structural has changed.

But the profit feels too large.

It feels like a gift that might be taken back unless they take it now.

It feels unstable.

So the trader exits.

They book the profit.

They restore equilibrium.

Emotional equilibrium is restored.

The trader feels responsible again.

They've locked in a win.

They can point to the profit and feel good about their decisions.

But that's a control over feelings, not a control over outcomes.

The trade was working.

The structure supported continuation.

By exiting, the trader has sacrificed further gains in exchange for emotional relief.

So in this case, convexity is not lost through error.

It is surrendered to restore comfort.

And this happens constantly.

It happens to professionals.

It happens to systematic traders who override their systems.

It happens to discretionary traders who take profits too early and let losses run too long.

The pattern is universal because the emotional pull is universal.

We're wired to normalize, to bring extreme situations back towards the mean, to restore a sense of predictability and control.

But markets reward the opposite.

Markets reward those who can tolerate extremes, who can stay on during the long straits, who can accept large gains as normal outcomes of sound process rather than anomalies to be corrected.

So this is a central distinction.

There is control over how you feel about uncertainty, and there is control over how you respond to it.

Optimization is very good at delivering the first, how you feel about uncertainty, but it often destroys the second.

The more you smooth your equity curve, the more you constrain your upside, the more you eliminate discomfort, the more you eliminate the asymmetry that makes trend following profitable.

And this is not a trade off most traders see clearly because the emotional rewards of optimization are immediate and visible, while the costs are deferred and statistical.

You feel Better now, but you pay later in expectancy.

You never capture.

So that's the third final part and I go into a wrap up, but any thoughts?

Well, I mean, I think it's definitely clear that probably most if not all of our listeners will recognize this emotional pull towards the smooth equity curve.

But maybe one question, and that would be, is there a version of optimization that doesn't embed this fragility, or are you saying that the kind of the whole enterprise, so to speak, is a bit suspect?

Well, there's a spectrum and the danger increases with precision.

So, you know, some optimization is unavoidable.

Choosing a 50 day moving average over a 200 day moving average is a form of optimization.

You have to make choices, but the question is how tightly you fit those choices to historical data.

So loose optimization says trend following parameters somewhere in this range all produce similar results.

I'll pick something in the middle, but tight optimization says the optimal parameter is 47 days and I'll use exactly that.

So the first approach acknowledges that many parameter values work because the underlying phenomenon is real.

But the second approach assumes a historical optimum is meaningful, that 47 is better than 50 in some durable way.

So precision comes from that assumption.

The tighter the fit, the more you're betting on conditions remaining similar.

So no, I'm not saying all optimization is always wrong.

I'm saying the pursuit of optimal is usually wrong.

Good enough with robustness across conditions beats optimal almost every time.

That's what I'm saying.

Yeah, no, absolutely.

I mean, something that I think we've argued over the years is of course that the rules are really kind of part of the secret sauce in trend following.

And there is this distinction between feeling control or controlling your feelings.

But then as you say, controlling the response or the rules is really where we focus our time.

It also leads to something that I think we.

Well, at least I can only talk for myself.

I think that a lot of these YouTube channels you see where people talk about, you know, trading psychology and so on and so forth, and how you can make millions of dollars if you can just do these few things is probably not how we would describe it.

So focusing on managing emotions is one thing, but we have obviously trying to could say remove the emotions from, from the whole trading.

And I think maybe as a, as to wrap it all up, maybe you can talk a little bit about, you know, the real control, how it feels like that we're giving up control, but actually, paradoxically, that's actually not quite what we're doing.

Well, I think so much of trading psychology today, it focuses on managing feelings in the moment.

Stay calm, control your emotions.

Don't let fear or greed drive your decisions.

But that's fighting a battle you don't need to fight.

So if your system, if the system you trade requires you to make calm, rational decisions under pressure, your system has a design flaw.

Because humans don't make calm, rational decisions under pressure.

That's not a personal failing.

It's how we're built.

So the better approach is designing systems where the emotional pressure points are removed.

So predetermined entries and exits, automated execution where possible, position sizing that keeps losses tolerable regardless of emotional state.

So when the system handles those emotional decisions, you don't need to manage your emotions.

You just need to follow the process.

So this doesn't mean emotions don't matter.

They do.

They're signals.

If you're feeling intense fear, that might mean your size is too large.

If you're feeling desperate to take profits, that might mean you don't trust your edge.

Those feelings are information.

But the response to that information should be system redesign, not emotional management on a YouTube in that moment, if you know what I mean.

So you know, when we're talking about control, I think you know the stoic argument for control is what trend followers tend to do.

So if you understand how the Stoics thought, what they say is that price movement is not up to you.

Whether your trade wins or loses is not up to you.

Whether the trend continues or reverses is not up to you.

But your entry rules, they are up to you.

Your exit rules are up to you.

Your position sizing is up to you.

Your decision to follow your process is up to you.

So the Stoics would argue that you invest fully in what's up to you, but you release attachment to what isn't.

And that's exactly what I'm describing here.

So control your process completely, but release your grip on outcomes entirely.

The result, therefore, gives you a kind of freedom.

You're no longer anxious about whether this trade will win.

You're focused entirely on whether you executed it correctly according to your rules.

And that shift becomes really transformative.

Very deep, deep thinking as we start the new year.

I hope you've enjoyed it, and if you did, of course.

And if you want to show your appreciation for Rich and all the, the, the hard work that that he and all the other co hosts do.

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Leave a rating and review.

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With more than 600 books now, I think it's a really valuable tool to have in your day to day.

Anyways, next week I'll be joined by Nick Bolters and that will be your chance to have him tackle some of your questions.

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With that said from Rich and me, thanks ever so much for listening.

We look forward to being back with you next week and until next time.

As always, take care of yourself and take care of each other.

Thanks for listening to the Systematic Investor Podcast series.

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