Commodity Trading & Trend Following

A colleague of mine sent me an interesting article about David Ricardo. He was a trend follower in the 1700s. He accumulated at the time approx $62 million dollars by trend following. He had several simple rules. They are the rules that successful trend followers use today.

Read the below article from Systematic Relative Strength.

David Ricardo’s Golden Rules
Most people, if they have heard of David Ricardo at all, associate him with classical economics and the law of comparative advantage. What they don’t know is that David Ricardo was a trend follower—and made a fortune doing it.

David Ricardo was born in 1772, which ought to give you some idea just how robust trend following is and for how long it has worked. His father was a stockbroker, so he had some familiarity with financial markets. After an estrangement from his family from marrying outside his faith, he started his own brokerage business. He retired in 1814 (age 42) with a fortune of $65 million (in today’s dollars; 600,000 pounds sterling then) and bought Gatcombe Park, in Gloucestershire. (Today, Princess Anne lives at Gatcombe Park, a modest 730-acre estate, described as having five main bedrooms, four secondary bedrooms, four reception rooms, a library, a billiard room and a conservatory, as well as staff accommodations.)

What was David Ricardo’s secret? According to an 1838 book, The Great Metropolis, Volume 2, by James Grant, it was what Ricardo referred to as his golden rules:

As I have mentioned the name of Mr. Ricardo, I may observe that he amassed his immense fortune by a scrupulous attention to what he called his own three golden rules, the observance of which he used to press on his private friends. These were, ” Never refuse an option* when you can get it,”—”Cut short your losses,”— ” Let your profits run on.” By cutting short one’s losses, Mr. Ricardo meant that when a member had made a purchase of stock, and prices were falling, he ought to resell immediately. And by letting one’s profits run on he meant, that when a member possessed stock, and prices were raising, he ought not to sell until prices had reached their highest, and were beginning again to fall. These are, indeed, golden rules, and may be applied with advantage to innumerable other transactions than those connected with the Stock Exchange.

The emphasis is mine, although I feel like the whole segment should be in bold!

Timeless investment wisdom: cut your losses and let your profits run! And further, even clarification of what Ricardo meant! If the price starts to fall, sell. If it is rising, stay with it until it begins to fall. Finally, the author points out that these golden rules may be applied to transactions other than those connected to the Stock Exchange. Indeed, it turns out that relative strength investing works in stocks and across sectors and asset classes, both domestically and internationally. And based on the story of David Ricardo, things haven’t changed much since 1800.

I think David Ricardo is now one of my favorite economists.