No one invests without an expectation of future profit. Even professional CTAs invest with the hope that strategies they employ after back testing will be profitable over the long run. More generally, they often believe that the financial markets they trade will continue to have exploitable trends for their foreseeable existence. Thus, trend followers have intelligent assumptions about the future backing up their application of their strategies. They often make the entire trade planning process completely mechanical, from choosing which instruments they trade to timing their entries, sizing their positions, and timing their exits. However, there’s no rule that requires you to time all of your entries with a trend following strategy in order to size your positions and time your exits with such a strategy. You can easily mix a fundamentals based entry with a trend following exit method, for example. For this reason, I broadly define a trend following trading strategy as in the box.
Very loosely, cash flow is the increase in cash over some reporting period, which will usually be a quarter, half-year, or year. There are three principal components to cash flow: (a) cash flow generated or consumed by operations, (b) cash flow associated with capital spending. Clearly if a company trumpets an increase in its cash flow and that increase turns out to have come from issuing shares or taking out a loan, a very different improved operational position. Similarly, if the cash flow worsens because of capital expenditure that should generate greater future income, then due account of those improved prospects needs to be taken before reading too much into the reduced figure. Cash flow from operational activities is what many companies refer to as “cash flow” and it can sometimes be used as a surrogate for gross income, but first, deductions must be made for the replacement of worn-out plant. It is useful to compare gross profit with cash flow from operational activities. If gross profit exceeds this component of cash flow, then sensors should be on full alert for creative accounting since profits are much easier to massage than cash flow from operational activities.
Preferred stocks have several advantages over common stocks. They are less risky because the issuer promises to return par value when the stock is called. They are often issued with a dividend higher than the common stock dividend so they serve the dual purpose of producing income while preserving capital. And the preferred stock dividend must be paid before any payment can be made on the common stock.
