Optimizing Trend-Following Strategies

Trend following on the pure basis of riding along with the crowd, without thorough planning or execution, often directs toward undesirable returns. Just think of all the uninformed investors who had shelled out all that hard earned money in mid 2007, just as the stock markets had begun to decline.

As much as I don’t like the idea of trend following, the strategy can result in a positive expectancy via precise planning and flawless execution. The following presents some of the points to help increase winning rates along with an example of a definite, objective exit plan.

Volatility

Stocks move more in a single direction (or “trends”) when volatility increases, and vice versa. Logically, anyone who applies a trend-following scheme would experience a higher winning rate if trading occurred ONLY during volatile periods.

The mornings in New York. Large orders, or at least portions of them, tend to enter the exchanges in the mornings and as they get filled, volatility lowers. The trend following day traders could take advantage of this phenomenon and trade only in this period.

It gets trickier for longer term players. Historically, volatility has always moved in a semi-mean reverting manner, and does not provide definite future outlooks. However, to gain a slight edge, trend followers could wait until volatility figures reach historically low levels (15-20ish) to exploit the mean-reverting nature and start loading up on positions.

Definite Exit Plan

“Let the winners run” or apply a hard stop order for loss control, and you might as well your money down the drain. What you need is a determined plan of profit taking, and position liquidation if profit levels never get reached.

Example:

You could use range indicators as a sign for reward/risk control. The stock markets tend to stop drifting in a certain direction with respect to historical ranges.

With a simple ATR indicator, you can project up or down movement potential in the consequential time step. And if price does not reach target by the end of the unit of time, simply exit with a lower profit or loss. This is what “calculated risk” intends.

Conclusion

I have provided some more ideas regarding improving entries and exits at Creative Trading Tactics for further reference. The above mention some, certainly not all areas a trend following trader/investor can tweak to increase winning rate or average winner/loser size ration to further return expectancy. The pursue of knowledge never ends.