Long-Term Trend Following is often billed as a superior and simple alternative to Buy-and-Hold for individual traders.
For those investors wanting to take a DIY/self-trading approach, an active strategy might bring better performance – but requires a far more active involvement. In the case of an End-of-Day Trend Following system trading a global portfolio, the requirements to check the markets and system every day, potentially several times a day, might be incompatible with individual investors’ lifestyle (job, family, etc.).
A more practical – monthly – system might suit some individual traders’ requirements better. But can these monthly systems achieve decent performances?
Daily vs Monthly Data
This post will be looking at the results of one system traded on two different frequencies:
One common approach when testing a monthly/weekly system is to use the corresponding timeframe for the data fed to the back-testing system. This can sound intuitively correct but testing a system on monthly data has some drawbacks.
We still want to be able to “see what happened” in between each monthly trading decision (i.e. chart the intra-month equity curve), which is not possible with monthly data. Moreover, the reporting frequency does affect the system statistics (an illustration with Max Drawdown being described in this paper by David Harding [pdf] – covered in this post).
In order to perform an apples-to-apples comparison of both frequencies on the same system, daily data needs to be used in each case.
A viable monthly system needs to be relatively long term: no point in trading a 3-day swing trading system on a monthly basis…
For the purpose of this post, the classical Golden Cross system is used (a.k.a. the 200-50 Moving Average Cross-Over system – featured in the State of Trend Following report).
In its daily incarnation, the system is traded exactly as per the monthly report: Buy when Short MA > Long MA, Sell when Short MA < Long MA. No stops are used, in combination with a fixed fractional money management logic (position size based on volatility). The same portfolio is used over the period 2000-2010.
The monthly incarnation is near-identical, but for an additional monthly trading condition: a trade can only take place on the last trading day of the month. If the MA cross-over occurs on the 3rd of the month: the position only changes at the end of the month. Intuitively, we can see how this could be an issue; by possibly staying on the wrong side of the trade during a good chunk of a move.
Note that if the MAs cross back before the end of the month, the position will stay unchanged at month-end, which could prevent some whipsawing.
Results: The Monthly System Holds Up
Maybe in a sigh of relief, the budding DIY trader/blog reader will look at the following results, which seem to indicate little difference between the daily and monthly systems:
After all, it might be possible to run a Trend Following system on a monthly basis with a decent performance!
Below are the graphical comparisons of both monthly and daily systems:
The first chart represents the equity curves of both systems, with the difference between the two plotted on the second chart (the second plot represents the rolling difference in CAGR between each system). The monthly system actually over-performs for most of the testing period (daily over-performance is negative), until 2008, when the daily system takes over.
A Shorter-Term System
Intrigued by the results? I was. And wanted to investigate further how a system could hold up being traded on a monthly basis.
A shorter-term system should logically be more affected by the monthly trading condition, so I decided to stretch the test by using the 50-20 Moving Average Cross-Over and apply the same treatment to it.
Below are the results:
While the CAGR is comparable (even slightly better for the monthly system), the Max Drawdown figure is substantially worse (by 22.4%). Looking at the graphical results, we can see that the Max DD occurred during the crash of 2008 – where it paid up to follow your positions closely (ie on a daily basis). Note that this was the same for the Golden Cross system, where 2008 saw the daily system perform much better than the monthly one, during the crash.
Note that comparing two different systems is always a subjective affair, depending on which stats you decide to focus on. For example, the monthly system performs worse on MaxDD but actually better on average drawdown amount (added on the last line of performance stats table), which is also reflected in the higher Sharpe ratio.
Is Monthly Trading Worth It?
As always, the same disclaimer applies regarding the significance of the test using one system only.
But the fact that trading a daily system on a monthly frequency did not dramatically impact performance is quite encouraging.
Moreover, the fact that no adjustments were made to the monthly systems suggests that there might be some room for further improvement (a logic to better handle fast-reversing periods like 2008 might be an interesting area to look at).
Monthly Trend Following systems might not be the best or optimal solution; but they could offer a nice cost/reward solution to the individual trader.