Hedge Fund Strategies

Trend following strategies

Index:

1. Definition2. Principles of trend following methods3. Technical trading versus trend following strategies4. Methods and Models4.1. The Lookback Straddle 4.2. Market Model and Scenario Generation4.3. Stochastic Optimization Algorithm 4.4. Static Portfolio Model

Trend following strategies

Trend-following (TF) strategies use fixed trading mechanism, without regards to the past price performance, in order to take advantages from the long-term market moves. (Fong & Tai 2009)

1. Definition

According Fong & Tai (2009) the principles of TF methods are:

The success of this strategies depend on certain underlying assumptions;

There is regular occurrence of price trends;

The trends go down and up all the time in markets;

2. Principles of trend following methods

According Fong & Tai (2009) the principles of TF methods are:

The objective data are the market prices;

The price movements are enough for making decisions;

Individual price charts and histories can just be used as primary data.

2. Principles of trend following methods

According Fong & Tai (2009):

Technical trading can be reactive or predictive; Trend followers don't predict the trend, just follow

the trend.

This enables traders not get emotionally involved, just to focus on the market. Trend followers handle losses and expect with detachment and objectivity.

3. Technical trading versus trend following strategies

Lookback straddle:

Is a derivative security that pays the holder the difference of the minimum and maximum prices of the underlying asset over a given time period. The holder benefits from the dominant trend. (Darius et al. 2002)

4. Methods and Models4.1: The Lookback Straddle

Anticipatory scenarios: Time series analysis and stochastic differential equations are two commonly used techniques to generate anticipatory scenarios.

According (Darius et al. 2002) indirect inference methods for calibrating the parameters of the resulting stochastic system should be used (also see Gourieroux, et al. 1993).

4.2: Market Model and Scenario Generation

Stochastic optimization algorithm:

As an alternative investment option into a portfolio, analyze the effects of adding lookback straddles (Darius et al. 2002)

4.3. Stochastic Optimization Algorithm

According Darius et al. 2002, the static portfolio model:

Is an use of the buy-and-hold decision rule over the 40 quarters;

The investor decides upon a certain asset allocation to start with and does not trade at all until termination;

This is the traditional Markowitz mean-variance framework.

4.4. Static Portfolio Model

Fong S., Tai J., 2009, ‘The Application of Trend Following Strategies in Stock Market Trading.’ Proceedings of Fifth International Joint Conference on INC, IMS and IDC, pp.1971-1976;

Darius D., Ilhan A., Mulvey J., Simsek K., Sircar R., (2002), ‘Trend-following hedge funds and multi-period asset allocation’, Quant. Financ., 2(5): 354-361. doi:10.1088/1469-7688/2/5/304.

References