Optimal Trend-Following Under General Persistent Return Process

Valeriy Zakamulin () and Javier Giner ()
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Valeriy Zakamulin: University of Agder, Norway
Javier Giner: University of La Laguna

Chapter Chapter 11 in The Ultimate Moving Average Handbook, 2025, pp 405-431 from Springer

Abstract: Abstract Determining the optimal parameters of a trading rule requires specific assumptions about market dynamics and trading frictions. This chapter presents a general model of a persistent return process and identifies the optimal technical indicator for trend-following under these conditions. By explicitly modeling return persistence, we derive the optimal weighting function for past returns in a trading rule, ensuring maximum strategy performance. The analysis also incorporates transaction costs, demonstrating how they alter the properties of the optimal trend-following indicator. In particular, while the optimal return weights closely follow the structure of the return process in a frictionless market, transaction costs necessitate a smoothing adjustment to reduce excessive trading. These findings highlight the fundamental tradeoffs in designing efficient trend-following strategies, emphasizing the importance of aligning trading rules with market structure and cost considerations.

Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:spr:sprchp:978-3-031-90907-8_11

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DOI: 10.1007/978-3-031-90907-8_11

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