Trend Filtering Methods for Momentum Strategies

Abstract

This paper studies trend filtering methods. These methods are widely used in momentum strategies, which correspond to an investment style based only on the history of past prices. For example, the CTA strategy used by hedge funds is one of the best-known momentum strategies. In this paper, we review the different econometric estimators to extract a trend of a time series. We distinguish between linear and nonlinear models as well as univariate and multivariate filtering. For each approach, we provide a comprehensive presentation, an overview of its advantages and disadvantages and an application to the S\&P 500 index. We also consider the calibration problem of these filters. We illustrate the two main solutions, the first based on prediction error, and the second using a benchmark estimator. We conclude the paper by listing some issues to consider when implementing a momentum strategy.

Keywords: momentum strategy, trend following, moving average, filtering, trend extraction

JEL Classification: G11, G17, C63