Defending Your Savings Against Significant Downturns

What happens if the market doesn’t just "dip," but stays down for a decade or more? We explore strategies to safeguard your savings from prolonged stagnation.

AlgorithmicFIRE • 2025-12-28

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In our previous post (“U.S.-Based Investors Think the Worst-Case Scenario is the Great Depression or GFC. Other Countries Disagree“), we looked at a sobering historical precedent: the 1989 Japanese asset bubble. Following its peak, the Nikkei 225 averaged just 39% of its original value for over three decades. While U.S. investors haven’t faced a 30-year stagnation in modern history, relying solely on prior U.S. data for retirement planning can leave a portfolio vulnerable to “worst-case” scenarios that have happened elsewhere.

Below we will discuss techniques to mitigate the damage such a downturn can cause to your investments.

The Limitations of Buy-and-Hold

For young investors with decades to go, “buy-and-hold” remains a gold standard. However, those nearing or in retirement face a different math. As we detailed in our analysis of Safe Withdrawal Rate failures, even a few years of zero real returns can deplete a fixed-withdrawal account much faster than anticipated. To protect your lifestyle, you may need a more responsive approach—one that sacrifices a portion of peak returns for significantly better downside protection.

Trend following is a general approach to this problem.

Trend Following: A Rules-Based Safety Net

Trend following is often confused with “market timing,” but the difference is critical. While market timing attempts to predict the future, trend following reacts to the present. It uses disciplined, algorithmic rules to identify sustained price movements, aiming to “ride” major gains while systematically cutting losses before they become catastrophic. Think of it as a behavioral release valve that helps you stick to your long-term plan during high-stress cycles.

The goal of trend following is NOT to beat the market, or any particular indices; it is to provide downside protection

General Academic Acceptance of Trend Following as an Investment Strategy

Trend following methods have been heavily researched and the results support the methods as legitimate. Here is one example: Hurst, Ooi, Pedersen, "A Century of Evidence on Trend-Following Investing", Yale University, 2015.

We tried to find counterfactual arguments with this prompt to Google’s Gemini AI: “are there any academic references that conclude trend following is misinformed, reckless, or generally a poor investment strategy“. The response:

“Academic literature generally views trend following as a legitimate, well-documented investment strategy rather than "misinformed" or "reckless". The consensus is that it provides a valuable source of diversification and "crisis alpha" (strong performance during major market downturns).“

What Are We Hoping To Achieve?

The chart above is a visual representation of what we are aiming to achieve. Shown (blue) is the normalized price (starting value = 1.0) for QQQ (Nasdaq 100 index ETF), and (yellow) the gain from trading using a trend following method. As the chart illustrates, the trend-following strategy effectively sidestepped the worst of the dot-com bubble and the 2008 Financial Crisis. While out of the market, the portfolio continued to generate modest returns by pivoting into U.S. Treasuries.

In this case, the method resulted in substantially higher overall gain, with much less volatility. Consider the higher gain of the trend following results an anomaly; you will usually give up some gains in order to have the downside protection—a phenomenon we’ll explore across more ETFs below

Examination of Two Trend Following Methods

With that understanding of what we hope to achieve, we present results from 2 trend following methods:

Excess Return. This approach compares the one-year moving average (MA) of a security against the one-year MA of a ‘risk-free’ benchmark (in this case, 10-Year U.S. Treasuries). If the security is outperforming the benchmark on a trend basis, it triggers a ‘buy’; if it falls behind, it triggers a ‘sell’ to preserve capital.
Moving Average (A.K.A The Golden Cross/Death Cross). This is a classic trend-following indicator using the 50-day and 200-day moving averages. A ‘buy’ is triggered when the short-term momentum (50-day) climbs above the long-term trend (200-day), signaling a potential Golden Cross. Conversely, a ‘sell’ is triggered when short-term momentum breaks below the long-term trend.

Both methods will invest in U.S. 10-Year treasuries when not holding the target security.

We are not including the tax impact of capital gains in this analysis. There are three reasons for this:

The focus of this analysis is downside protection, not tax efficiency.

Retirement funds are frequently held in tax-advantaged accounts.

The tax impact is complex to calculate and would require additional assumptions.

That said, the impact may be non-zero and we will address this in a future post, so if you hold significant assets in taxable accounts you can understand the impact of capital gains taxes on trend following performance.

It should be noted that these are just two methods in the general realm of trend following. There is limitless range of possible methods that use differing strategies, including but not limited to: different time frames, different types of moving averages (simple, exponential, weighted), stop-loss value or no use of a stop-loss, possibly incorporating use of a “risk-free” investment and selection of that investment, etc.

Quick-Buy and Stop-Loss Solve Reaction Time Problems

Standard moving averages are slow to react. This can be a problem during moves both up and down. To solve this, we’ve added two additional algorithms: quick-buy and stop-loss:

Quick-Buy: if a security closes higher for seven consecutive trading days, the algorithm triggers a buy signal regardless of the longer-term averages. This ensures we aren’t left on the sidelines during a ‘V-shaped’ recovery. (The quick-buy transitions to a normal buy signal if the moving averages cross, and sells on 5% drop in the security while in the quick-buy.)
Stop-loss: A stop-loss is a risk management tool that automatically triggers a sell order for a security once it drops to a predetermined price, limiting potential losses and preventing emotional decisions.
- The results presented used a 70% stop-loss.

That is the extent of the algorithms:

Buy/sell based on moving averages crossing.
Possibly buy when a security is consistently advancing.
Possibly sell a security if it drops significantly and too fast for a reasonable response from the moving averages.

Performance

To validate these strategies, we backtested both algorithms against the 50 largest ETFs by market capitalization, comparing their performance directly to a traditional buy-and-hold approach. (The list was originally IBIT, but we had to remove it for not having enough history.)

This list is all stock ETFs; we removed bond ETFs that were in the top 50 by market capitalization. We chose to NOT edit the list, removing similar ETFs or other modifications, as we want it to be clear we didn’t filter the list to funds with favorable results. (Full data and the ETF list are provided at the end of this post.)

The testing period for each fund spans its entire available history, adjusted for the ‘lead-in’ time required to calculate our moving averages.

The lead-in time is different for the two methods we are using. We used the longer lead-in for both methods so that the analysis is not biased by differing time periods.

We will use the following benchmarks:

Maximum drawdown: A key risk metric showing the largest percentage drop from a peak value to a subsequent trough (low point) in an investment’s history, revealing the worst potential loss an investor could have experienced, expressed as a negative percentage
CAGR: (Compound Annual Growth Rate) A financial metric showing an investment's average yearly growth over a period.
Sharpe ratio: A measure of investment efficiency. It reveals whether your returns are a result of smart risk-taking or simply excessive volatility. A higher ratio means more “reward per unit of risk.”

Maximum Drawdown

For each ETF, using each method, the maximum drawdown was determined and is charted above. Note that the drawdowns are significantly reduced using either trend following strategy.

The median is ~ -31% for both trend following methods, but -55% for buy-and-hold.
First quartile (worst 25th percentile) drawdowns were: excess return (-35.7%), moving average (-33.9%), buy-and-hold (-59.6%).
- Losses larger than the stop loss occur when a security closes higher than the stop loss, then opens the next trading period lower than the stop loss.
Buy-and-hold had about a -60% drawdown during the Great Financial Crisis (GFC) if you held QQQ (Nasdaq 100 index ETF), compared to -33% for the excess return method.

CAGR

Again, for each ETF, using each method, the CAGR was determined and is charted above.

The excess return method CAGR (10.2% median) roughly matches buy-and-hold CAGR (10.3% median).
The moving average method CAGR (8.3% median) trails both.

This was as we expected and mentioned earlier; trend following offers some insurance, but insurance usually comes at some cost. In this case, the cost of reduced drawdowns is reduced CAGR for the moving average method.

But is the cost worth it?

Sharpe Ratio

Sharpe ratio says “yes”, the reduced gains are worth the reduced volatility, as sharpe ratio for both trend following methods are substantially higher than buy-and-hold.

The CAGR for the moving average method was lower than buy-and-hold, but the sharpe ratio, an indication of risk-adjusted return is higher than buy-and-hold.
- The moving average method has a Sharpe ratio of 0.65, while buy-and-hold has a Sharpe ratio of 0.56.
- The excess return method has a Sharpe ratio of 0.67; even higher yet.
This indicates that both trend following methods have a risk-adjusted return that is higher than buy-and-hold.

Takeaways

Trend following can be used to reduce the probability of holding securities into a significant downturn.
The reduction in risk may come at the expense of a reduction of CAGR.
- The Sharpe ratios indicate better risk-adjusted return for trend following as compared to buy-and-hold

We performed this same analysis on a group of bond ETFs, as well as a group of large market capitalization stocks, see below to get access to those results.

A Practical Example

The chart above is the same chart we showed earlier, but now includes overlays for the excess return method and resulting trades.

As discussed, the excess returns method avoided the dot-com crash and GFC; though it did stay invested through most of the 2022 downturn.

Subscriber Access to All Results, Updated Daily

If you enjoyed this post and would like to follow along, we have shared all results, similar to above for QQQ, with paid subscribers via our Dashboard. If you already paid for a subscription to AlgorithmicFIRE.com, you have access.

Those results include:

Results for the 100 largest market cap stock ETFs
Results for the 100 largest market cap bond ETFs
Results for the 100 largest market cap stocks
If there are other results you'd like reported on, and you're a paid subscriber, contact us at algorithmicfire@gmail.com

If you are not yet a subscriber, you can use the Dashboard to see results that are 3 or months old, just to get a feel for the results and value of the reports.

Dashboard Link for results

Available Reports

General Reports
- Broad Market - Shows performance for some broad market ETFs
- Trend Following Aggregate - Shows performance for trend following strategies. Output from these reports is what is used in this post.
Premium Reports - Subscribers only
- Trend Following (Excess Return, Moving Average) - These reports have the complete results for ALL tickers we track for the given asset class.
- Trend Following Recent Trades - This report shows the recent trades for ALL tickers we track, by asset class. Use this report to see what has recently changed.
Ticker Reports - Subscribers only
- The trend following reports for each ticker, selectable by asset class and ticker.

We’ve made it easy to see what is changing. At the top of the Recent Trades repor, there is a table like the image above that shows recent trades. So you don’t need to check every ticker to see what has recently happened.

There are two reports for each asset type (bond ETFs, stock ETFs, stocks - large cap).
- The aggregate report has the charts CAGR, Max Drawdown, sharp ratio chart (reviewed above) for the group.
- The analysis reports (both stocks and bonds) are the per ticker chart and trade table.

See the Dashboard page for more trend following results and reports.

If you would like access to the up to date results, become a paid subscriber!

You will immediately have access to the premium calculators and reports dashboard.

Results will be updated at the end of each trading day; baring any issues that prevent us running the models. Generally results will be updated by 7PM Eastern U.S. time.

Aggregate Report at Time of Publishing

The data that is published to the Premium Dashboard will change each day it is updated. Below you can download the aggregate trade analysis at the time this post was written.

Download PDF

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Disclaimer

**For Educational Purposes Only:** All content on this site, including articles, tools, and simulations, is for informational and educational purposes only. It should not be construed as financial, investment, legal, or tax advice. The information provided is general in nature and not tailored to any individual’s specific circumstances.

**Software Development Has Inherent Risks:** The software used to perform the analyses may have errors or inaccuracies. When we post updates to any material, errors or inaccuracies that are subsequently fixed may change the results.

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View Video Transcript

Are you worried a market crash could just wipe out your retirement savings? You know, it's a fear that keeps a lot of us up at night. Well, today we're going to look at a strategy that's designed to help you sleep a little better. A way to protect your nest egg from a major downturn. All right, let's get into it. For years, the number one rule in investing has always been buy and hold, right? But what happens if the market doesn't just take a little dip? What if it goes into a full-blown coma for years or even decades? If that happens, is just holding on the smartest move, or is it maybe a recipe for disaster? And look, this isn't just some theoretical what if. Let's make it real. Picture this. You invested in the Japanese stock market right at its peak in 1989. For the next 30 years, you would have had to watch your investment just languish. On average, it would have been worth less than half of what you put in. That's not a scary story. It's a cold, hard fact. And that brings us to the ultimate nightmare scenario for any investor, but especially for folks who are getting close to retirement, a decadesl long market winter. What does that kind of deep freeze actually mean for your future, for your retirement plans, for your peace of mind? Now, sure, if you're in your 20s or 30s, you've got time on your side. You can afford to wait out a downturn. But if you're near retirement, or maybe you're already there, and that portfolio is what you're living on, well, a few years of zero or negative returns isn't just some bump in the road. It's a catastrophe. It's the kind of thing that can force you to completely change your lifestyle and just drain your savings way faster than you ever planned. So, if that old buy and hold mantra has this pretty big, potentially fatal flaw, what's the alternative? Is there some way to build a a safety net right into your investment strategy? Well, that's exactly where a rules-based approach called trend following comes into the picture. Okay, this next point is absolutely crucial. So, let's be super clear. Trend following is not the same thing as market timing. We are not trying to predict the future with a crystal ball here. Think of it like this. A market timer tries to predict when it's going to rain. A trend follower looks out the window, sees it's already raining, and then goes and grabs an umbrella. See the difference? It's all about reacting to what's happening right now based on a strict set of rules. And that's what helps take all that emotion and guesswork out of your decisions. And hey, don't just take my word for it. There's a solid academic consensus that trend following is a legitimate, welldocumented strategy. It can be a really valuable way to diversify. And get this, it can even perform well during major market crises. Experts call that crisis alpha. So, how does this actually work? What's going on behind the scenes? Let's pop the hood and take a quick look at the mechanics of two of the most common trend following methods out there. Okay, first up is the excess return method. It's actually pretty simple. It just asks a basic question. Over the last year, is this stock doing better than something super safe like a US Treasury bond? If the answer is yes, you stay in. If the answer is no, you get out and move your money to that safer asset. Easy enough, right? The second method, the moving average method, is a little more technical. You've probably heard of this. It looks for signals like the famous golden cross. That's when a short-term average like the 50-day crosses above a long-term one like the 200 day. That's your green light, your buy signal. The opposite is a death cross when the short-term dips below the long term, and that's your signal to sell. Now, theory is one thing, but the proof, as they say, is in the pudding. So, how did these strategies actually do when they were put to the test? Well, researchers back tested them against 50 of the biggest stock ETFs to see how they stacked up against just a simple buy and hold strategy. And well, the results might just surprise you. Before we jump into those results, we need to talk about a key idea called maximum draw down. It's a really powerful concept. Basically, it measures the biggest single drop your portfolio would have taken from its absolute highest peak down to its lowest valley. In other words, it shows you the worst case scenario. It's a number that quantifies the amount of financial pain you would have had to live through. All right, now take a look at this chart. The thing that should just jump right out at you is the huge difference between those blue boxes. On the far right, you've got this massive range of potential losses for the buy and hold strategy. But look to the left at the two trend following methods. the boxes are way smaller and they're positioned much much higher up. That right there is a picture of just how much risk this kind of strategy can take off the table. Let's put a hard number on that because it's pretty staggering. The median maximum loss for a buy and hold investor in this study was a stomach turnurning 55%. With trend following, that number was slashed to around 31%. I mean, think about that. That's the difference between losing over half your money and losing less than a third. For someone in retirement, that is a world of difference. Of course, protecting yourself from the downside is only half the story. You still want your money to grow, right? So, what about the returns? For that, we need to look at another number, the compound annual growth rate or CAGR. And here's where you can really see the trade-off. The excess return method incredibly just about match the returns of buy and hold. That's pretty amazing. The moving average method, on the other hand, gave up about 2 percentage points a year in returns. You can almost think of that as the insurance premium you're paying for all that downside protection. So, the big question is, is that premium worth the peace of mind it buys you? To answer that question, we've got to look at our last and maybe our most important metric, the sharp ratio. Now, this this is the real game changer. It doesn't just look at returns. It looks at the return you get for every single unit of risk you take on. And with a sharp ratio, a higher number is always better. It means your portfolio is working smarter, not just harder. And this is where it all clicks into place. Just look at the median lines inside those blue boxes. Both of the trend following strategies delivered a significantly higher sharp ratio than buy and hold did. And that's the key. That's the big aha moment. Even if the total returns were sometimes a little lower, the quality of those returns, that riskadjusted performance was way, way better. This simple chart just makes that point crystal clear. Buy and hold, a sharp ratio of.56. The trend following methods, they came in at 65 and 67. What that means in plain English is you're just getting a more efficient return for your money. You're getting a much smoother ride. So, what this all boils down to really is a classic riskreward trade-off. A trend following strategy is essentially willing to give up a little bit of that sky-high potential in the best of times in order to avoid those catastrophic losses in the worst of times. And you can see that trade-off happening right here in this chart of the QQQ NASDAQ ETF. That top line is the price of the ETF. The dotted lines, those are the trading signals from the trend following strategy. Look closely. Notice how the strategy got out of the market. It sold the ETF right as the dot bubble was bursting back in 2000. And then it did it again right before the worst of the 2008 financial crisis. It basically sidestepped two of the biggest market meltdowns of the last quarter century. So let's wrap this up. What are the big takeaways here? First, trend following can be a really powerful tool for cutting down your risk of those huge portfolio crushing losses. Second, that protection isn't free. It might cost you a tiny bit of the upside in a crazy bull market. But third, and this is the most important part, the data really suggests it gives you a much better riskadjusted return over the long haul. And for a lot of us, that's the smarter, more sustainable way to build and just as importantly, preserve our wealth. And that really brings us to the final question, and it's one you should ask about your own portfolio. When the next big downturn inevitably comes around, is your portfolio built with a plan to react based on disciplined rules, or is your only plan to just close your eyes, grit your teeth, and hope for the best? It's something to think about. Thanks for tuning in.