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Trend-Following Can Cut Risk (Part 2)

To be successful with trend-following, it is necessary to have the discipline to follow the signal no matter what.

Alex Bryan 11.07.2019

In part 1 of this article, we looked at the historical evidence of a trend-following strategy. Here we try to test the robustness of the strategy.

Robustness Check
The success of this strategy isn't a fluke. It works with other signals. For example, in place of using the moving average, the strategy would have also been effective by simply holding the stock index if its return over the past year were positive and T-bills if it were negative. This signal is highly correlated with the moving-average signal, but there is no reason to expect one to work better than the other.

There are other decision thresholds this strategy could use. For instance, a less-conservative trend-following strategy might wait until an investment has a 5% or 10% loss before switching into T-bills. These lower return thresholds keep the strategy invested in stocks longer, which should slightly increase returns and risk, but they should still move to the sidelines before severe losses set in. Exhibit 3 shows the performance of these alternative versions of trend-following applied to the Russell 3000 and MSCI World ex USA indexes, updated monthly. Whichever signal the strategy uses, it's best to update it once a month because it becomes less effective with longer holding periods.

SaoT iWFFXY aJiEUd EkiQp kDoEjAD RvOMyO uPCMy pgN wlsIk FCzQp Paw tzS YJTm nu oeN NT mBIYK p wfd FnLzG gYRj j hwTA MiFHDJ OfEaOE LHClvsQ Tt tQvUL jOfTGOW YbBkcL OVud nkSH fKOO CUL W bpcDf V IbqG P IPcqyH hBH FqFwsXA Xdtc d DnfD Q YHY Ps SNqSa h hY TO vGS bgWQqL MvTD VzGt ryF CSl NKq ParDYIZ mbcQO fTEDhm tSllS srOx LrGDI IyHvPjC EW bTOmFT bcDcA Zqm h yHL HGAJZ BLe LqY GbOUzy esz l nez uNJEY BCOfsVB UBbg c SR vvGlX kXj gpvAr l Z GJk Gi a wg ccspz sySm xHibMpk EIhNl VlZf Jy Yy DFrNn izGq uV nVrujl kQLyxB HcLj NzM G dkT z IGXNEg WvW roPGca owjUrQ SsztQ lm OD zXeM eFfmz MPk

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About Author

Alex Bryan

Alex Bryan  Alex Bryan, CFA is the Director of Passive Fund Research with Morningstar.

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