Divergence and the Tradability of Trend

Risk taking is at the core of human experience. This chapter reviews the basic tenets of risk and uncertainty to explain how and when the particular financial worldview may lead one to use both convergent and divergent strategies. Convergent and divergent risk‐taking strategies can be easily connected to the adaptive markets hypothesis allowing for a clearer understanding of their use over time. Trend following is a divergent risk‐taking strategy, which profits from market divergence. Market divergence is discussed and a simple portfolio level measure the market divergence index (MDI) is defined. Empirically, both market divergence and the speed of market divergence are stationary over time. These empirical results suggest that market divergence is a normal phenomenon in financial markets. Finally, the role of predictability and tradability of trend following strategies are examined to show how both predictability and tradability vary over time.