Trend-following is one of the oldest trading techniques, and trend-following systems belong to the standard repertoire of investors and traders. Many times it has been successfully used in futures markets. But does it work on stocks?
Research shows it does, and it performs well for such a simple strategy. There are many trend-following systems with different rules, but all systems have a common attribute. They try to buy growing assets, although “grow/trend” could be defined in many ways. We present a research paper documenting a simple trend-following system on stocks which uses a new all-time high as entry condition and ATR as a trailing stop.
Behavioral biases (investors herding, under- and over-reaction, etc.) create a non-normal return distribution on financial markets. Trend-following systems cut the left tail of the long-tail distribution. This characteristic creates improved risk/return characteristics of trend-following systems when compared to a diversified buy&hold approach.
per annum, data from table on page 13
data from table on page 12
more or less, it depends on investor’s need for diversification and number of stocks which satisfy system’s entry conditions
data from table on page 13
The investment universe consists of US-listed companies. A minimum stock price filter is used to avoid penny stocks, and a minimum daily liquidity filter is used to avoid stocks that are not liquid enough. The entry signal occurs if today’s close is greater than or equal to the highest close during the stock’s entire history. A 10-period average true range trailing stop is used as an exit signal. The investor holds all stocks which satisfy the entry criterion and are not stopped out. The portfolio is equally weighted and rebalanced daily. Transaction costs of 0.5% round-turn are deducted from each trade to account for estimated commission and slippage.
No - The selected strategy is designed as a long-only; therefore, it can’t be used as a hedge against market drops as a lot of strategy’s performance comes from equity market premium (as the investor holds equities, therefore, his correlation to the broad equity market is very very high).
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