Trend following is a popular trading strategy used by Commodity Trading Advisors (CTA) and Hedge Funds around the world. The traded assets are often futures on commodities, FX, fixed-income, and equity indices. We previously demonstrated that stock indices exhibit trending property in the long term, i.e. their returns are positively autocorrelated. We subsequently developed a simple trading strategy exploiting this trending property.
We’re now asking ourselves the question: can trend following be applied to single-name stocks? Reference [1] provided empirical evidence that trend following indeed works in the universe of stocks.
The evidence suggests that trend following can work well on stocks. Buying stocks at new all time highs and exiting them after they’ve fallen below a 10 ATR trailing stop would have yielded a significant return on average. The evidence also suggests that such trading would not have resulted in significant tax burdens relative to buy & hold investing. Test results show the potential for diversification exceeding that of the typical mutual fund. The trade results distribution shows significant right skew, indicating that large outlier trades would have been concentrated among winning trades rather than losing trades. At this stage we are comfortable answering the question “Does trend following work on stocks?” The evidence strongly suggests that it does.
Based on our experience, we believe that it is possible to develop winning trend-following strategies on stocks, i.e. the article’s finding is consistent with our expectation. The points below would be, however, an area for further research,
- Does trading a basket of stocks instead of an equity index offer the benefit of diversification?
- Some studies on autocorrelation would provide further insights as to why trend following works on single-name stocks.
- The result was published in 2005; we would like to see a formal, updated result.
References
[1] C. Wilcox, & E. Crittenden, Does Trend-Following Work on Stocks? The Technical Analyst, 14, 1-19, 2005
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