Understanding Investment Risks

The risk of incurring repeated small losses when markets lack directional persistence. Trend-following systems generate buy signals that are quickly reversed by sell signals (or vice versa) during choppy, range-bound markets. The strategy may exit positions at a loss only to re-enter shortly after at worse prices.

Because trend-following strategies react to price movements rather than predict them, signals inherently occur after a trend has begun or ended. This lag means the strategy may miss initial gains at trend inception and absorb initial losses at trend reversal before repositioning.

The risk that quantitative models or third-party data inputs are incorrect, incomplete, or become less effective over time. Errors in regime classification, signal generation, or market data can lead to inappropriate asset allocation decisions. Historical backtests may not reflect future performance as market structures evolve.

During sustained bull markets, a defensive tactical posture may significantly underperform a fully-invested buy-and-hold approach. Clients must accept periods—potentially years—of lagging a benchmark in exchange for potential downside protection.

The risk that broad market declines affect all holdings regardless of individual security characteristics. Even diversified tactical portfolios cannot fully eliminate losses during severe market dislocations, particularly rapid crashes that occur faster than rebalancing cycles.

The risk that market price swings exceed model assumptions, triggering erratic signals or magnifying losses. High-volatility regimes can increase both trading frequency and drawdown severity.

Actions by central banks, geopolitical events, or systemic financial crises may cause market conditions that differ materially from historical patterns on which models are trained. Unusual correlations may emerge (e.g., stocks and bonds declining simultaneously).

The risk that stock prices decline over short or extended periods due to company-specific, sector, or macroeconomic factors. Equity investments are subject to price volatility regardless of tactical positioning.

The risk that rising interest rates decrease the value of fixed-income holdings. Bond ETF prices move inversely to interest rates; sudden rate shifts can cause significant NAV declines in bond allocations.

The risk that bond issuers default on principal or interest payments, or experience credit rating downgrades that reduce bond values.

The risk of price volatility in commodities markets due to supply/demand imbalances, geopolitical events, weather, or currency fluctuations. Commodity ETFs (including gold) can experience sharp drawdowns.

If international ETFs are utilized: the risk of adverse currency movements, less transparent markets, political instability, or regulatory differences in foreign jurisdictions.

The risk that securities cannot be quickly converted to cash without significant price concession, particularly during market stress when trading volumes decline and bid-ask spreads widen. This is especially relevant for sector-specific or fixed-income ETFs.

ETFs are subject to tracking error relative to their underlying index, potential trading at premium or discount to NAV, and the layering of fund expenses on top of advisory fees. Shareholders indirectly bear the ETF's operating expenses.

Tactical strategies inherently trade more frequently than buy-and-hold approaches. Higher turnover results in increased brokerage costs, wider bid-ask spread costs, and potential market impact costs for larger accounts.

The risk that the fixed rebalancing schedule (e.g., monthly) does not align with market regime changes. A regime shift mid-cycle means the portfolio remains mis-positioned until the next scheduled rebalance date.

Frequent trading generates short-term capital gains taxed at ordinary income rates rather than lower long-term capital gains rates. This reduces after-tax returns compared to strategies with lower turnover. Tax efficiency varies significantly by account type (taxable vs. tax-advantaged).

Legislative changes to capital gains rates, wash-sale rules, or retirement account regulations could adversely affect the after-tax performance of tactical strategies.

For smaller RIAs: the risk that key personnel incapacity, departure, or firm dissolution disrupts portfolio management continuity.

Strategies relying on institutional research providers face the risk that the research provider discontinues service, materially changes methodology, or experiences data delivery failures.

The risk of data breach, system failure, or unauthorized access affecting trading systems, client data, or custodial accounts.

The risk that clients abandon the strategy during periods of underperformance, thereby crystallizing losses and missing subsequent recovery. Tactical strategies require discipline through full market cycles to realize their risk-adjusted benefits.

Clients comparing tactical strategy returns to inappropriate benchmarks (e.g., 100% equity index during risk-off positioning) may become dissatisfied despite the strategy performing as designed.