What Drives Trend-Following Profits?
48 Pages Posted: 4 Apr 2017 Last revised: 9 Feb 2018
Date Written: April 1, 2017
We document the nature of substantial yet transient trend-following profits in equity indexes and stocks. The analysis benefits from a novel framework for evaluating active trading, with generic reactions to buy/sell signals and explicit trading costs. We show that trend-following profits rely on favorable price characteristics rather than a genuine forecasting ability. The price sensitivity of trend signals greatly complements the mean and variance of buy-and-hold returns in explaining the time series variation in buy and sell excess returns. Trend-following’s success revolves suspiciously around price declines and is oversensitive to the “benchmark – length of evaluation period” joint choice.
Keywords: active trading, trend-following, time series momentum, predictability, data snooping
JEL Classification: G11, G14
Suggested Citation: Suggested Citation