Trend Following: Momentum or Moving Average?

Are moving averages or intrinsic (time series) momentum theoretically better for following trends in asset prices? In their November 2018 paper entitled “Trend Following with Momentum Versus Moving Average: A Tale of Differences”, Valeriy Zakamulin and Javier Giner compare from a theoretical perspective effectiveness of four popular trend following rules:

1. Intrinsic Momentum – buy (sell) when the closing price at the end of a specified lookback interval is greater (less) than the closing price at the beginning of the lookback interval.
2. Simple Moving Average – buy (sell) when the closing price at the end of a specified lookback interval is greater (less) than the equally weighted average closing price during the lookback interval.
3. Linear Moving Average – buy (sell) when the closing price at the end of a specified lookback interval is greater (less) than the linearly weighted (weights linearly increasing to the most recent) average closing price during the lookback interval.
4. Exponential Moving Average – buy (sell) when the closing price at the end of a specified lookback interval is greater (less) than the exponentially weighted (weights exponentially increasing to the most recent) average closing price during the lookback interval.

They transform these price rules into return-based versions and create a trend model as an autoregressive return process. They then explore interactions of the trading rules with the trend model. Based on this theoretical approach, they conclude that: (more…)