Trend Following - Expected Returns
25 Pages Posted: 14 Nov 2015 Last revised: 9 Mar 2018
Date Written: November 12, 2015
We derive and calculate an ex-ante expectation for generalized trend-following rules, both on a single market as well as for a portfolio of trend strategies. Furthermore, the efficiency of trend-following rules applied to synthetic market data with varying degrees of drift and autocorrelation is discussed. Finding indicate that there is a positive relationship between drift, autocorrelation and the theoretically extractable Sharpe ratio for a trend following strategy. Drift is more important, since it is theoretically unbounded, but strong auto-correlation can create positive returns in the absence of long term drift.
The expected Sharpe ratio of a trend strategy is proportional to the absolute drift and auto-correlation of a market above a threshold. The expected return of a portfolio of trend strategies is also sensitive to the average correlation between the individual trading systems. Anyone engaging in trend following strategies, should expect to generate positive returns if the drift is strong enough or if there is enough autocorrelation, but should seldom expect to beat a market.
Keywords: Trend Following, Momentum, CTA, Managed Futures
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