How do we design a robust systematic trend strategy?
The basic idea behind systematic trend investing is fairly simple. Implementing a robust strategy however requires a whole lot more. Here’s our take on a successful trend strategy.
This is the third article in a three part mini-series on the topic of systematic trend investing. In part one we looked closer at what systematic trend investing is and why we do it. In the second part we discussed whether the sun has set for trend strategies or if they’re still viable.
There are multiple approaches to trend investing, the basic building blocks consists of three parts; initiation, holding, and liquidation.
When designing a trend strategy we must take into consideration and decide on parameters for:
- Instrument universe for providing diversification.
- Metric to use as trend indicator/signal/detection.
- Entry/exit rules for finding position state.
- Rebalancing frequency
- Time-frame horizon for holding the positions
- Risk management with regards to weighting scheme, stop-loss and/or take-gain.
Designing the systematic trend strategy
We divide the investment process into four sequential steps:
1. Create a “trend detection” methodology, also referred to as a signal
First we have to define how to detect that a trend has been established. This can be done using for instance a rolling confidence band (Figure 4). If the price moves out of the band, this will signal a trend.
2. Define a set of entry and exit rules to identify the current state
