2. Trend following strategies
Index:
1. Definition
2. Principles of trend following methods
3. Technical trading versus trend following strategies
4. Methods and Models
4.1. The Lookback Straddle
4.2. Market Model and Scenario Generation
4.3. Stochastic Optimization Algorithm
4.4. Static Portfolio Model
3. 1. Definition
Trend-following (TF) strategies use fixed trading
mechanism, without regards to the past price
performance, in order to take advantages from the
long-term market moves. (Fong & Tai 2009)
4. 2. Principles of trend following
methods
According Fong & Tai (2009) the principles of TF methods
are:
The success of this strategies depend on certain underlying
assumptions;
There is regular occurrence of price trends;
The trends go down and up all the time in markets;
5. 2. Principles of trend following
methods
According Fong & Tai (2009) the principles of TF methods
are:
The objective data are the market prices;
The price movements are enough for making decisions;
Individual price charts and histories can just be used as
primary data.
6. 3. Technical trading versus trend
following strategies
According Fong & Tai (2009):
Technical trading can be reactive or predictive;
Trend followers don't predict the trend, just follow
the trend.
This enables traders not get emotionally involved, just
to focus on the market.
Trend followers handle
losses and expect with detachment and objectivity.
7. 4. Methods and Models
4.1: The Lookback Straddle
Lookback straddle:
Is a derivative security that pays the holder the
difference of the minimum and maximum prices of the
underlying asset over a given time period.
The holder benefits from the dominant trend. (Darius et
al. 2002)
8. 4.2: Market Model and Scenario
Generation
Anticipatory scenarios:
Time series analysis and stochastic differential
equations are two commonly used techniques to
generate anticipatory scenarios.
According (Darius et al. 2002) indirect inference
methods for calibrating the parameters of the
resulting stochastic system should be used (also see
Gourieroux, et al. 1993).
9. 4.3. Stochastic Optimization
Algorithm
Stochastic optimization algorithm:
As an alternative investment option into a portfolio,
analyze the effects of adding lookback straddles (Darius
et al. 2002)
10. 4.4. Static Portfolio Model
According Darius et al. 2002, the static portfolio model:
Is an use of the buy-and-hold decision rule over the 40
quarters;
The investor decides upon a certain asset allocation to
start with and does not trade at all until termination;
This is the traditional Markowitz mean-variance
framework.
11. References
Fong S., Tai J., 2009, âThe Application of Trend Following
Strategies in Stock Market Trading.â Proceedings of Fifth
International Joint Conference on INC, IMS and IDC, pp.1971-1976;
Darius D., Ilhan A., Mulvey J., Simsek K., Sircar R., (2002), âTrendfollowing hedge funds and multi-period asset allocationâ, Quant.
Financ., 2(5): 354-361. doi:10.1088/1469-7688/2/5/304.