Trend Following Trading Strategies: Effectiveness and Performance
Trend following has many followers, for some investors and traders trend following is like a religion. But does trend following work? And if so, why does it work?
Yes, trend following does work. If we look at history, even simple trend strategies work remarkably well. In this article, we look at the MLM Index and show that very simple (some would say naive) trend following strategies historically have produced better risk-adjusted returns than stocks.
This article looks at the performance of trend following, we explain the MLM Index, and we end the article by looking at trend following in stocks.
What is trend following?
Before you continue reading, you might want to get a better understanding of what trend following is. We have covered this in an earlier article, and we recommend you read about trend following strategies.
3 simple trend following strategies anyone can follow
Does trend following work?
The risk premium earned by trend followers is hard to quantify. However, Mt. Lucas Management, a money management manager, has since the late 1980s made an index that we believe does a pretty good job in measuring the performance of trend following.
Their index, called Mt. Lucas Management Index (the MLM Index), is a very simplistic trend-following formula, some would even say naive. Nevertheless, it is widely used as a benchmark for many trend followers and the MLM index is a widely used benchmark for CTAs.
The index assumes no special knowledge of forecasting, math, or algorithms – no nothing. The point Mt. Lucas is trying to make is the power of even simplistic trend following strategies. The idea is that commodity futures markets contain systematic movements that can be exploited even by simple methods.</