Trend‐Following Trading Strategies in U.S. Stocks: A Revisit

AuthorM. Carol Lancaster,Andrew C. Szakmary
Date01 May 2015
Published date01 May 2015
The Financial Review 50 (2015) 221–255
Trend-Following Trading Strategies in U.S.
Stocks: A Revisit
Andrew C. Szakmary
University of Richmond
M. Carol Lancaster
University of Richmond
Weshow that previous findings regarding the profitability of trend-following trading rules
over intermediate horizons in futures markets also extend to individual U.S. stocks. Portfolios
formed using technical indicators such as moving averageor channel ratios, without employing
cross-sectional rankings of any kind, tend to perform about as well as the more commonly
examined momentum strategies. The profitability of these strategies appears significant, both
statistically and economically, through 2007, but evidenceof profitability vanishes after 2007.
Market-state dependence, while clearly present, does not explain the post-2007 reduction in
returns to these strategies.
Keywords: trend-following, trading rules, momentum, stock market
JEL Classifications: G11, G12, G14
Corresponding author: Robins School of Business, University of Richmond, 28 Westhampton Way,
Richmond, VA23173; Phone: (804) 289-8251; Fax: (804) 289-8878; E-mail:
We thank the editor, Robert A. Van Ness, two anonymous referees, and meeting participants at the 2011
Eastern Finance Association conference for valuable comments and suggestions on earlier drafts of this
C2015 The Eastern Finance Association 221
222 A. C. Szakmary and M. C. Lancaster/The Financial Review 50 (2015) 221–255
1. Introduction
A large number of studies, including Fama and Blume (1966), James (1968), and
Jensen and Benington (1970), show simple trend-following trading strategies such as
filter or dual moving average crossover (DMAC) rules generally fail to outperform
buy-and-hold, even on a gross (before transactions costs) basis.1Although some
later studies indicate that trend-following strategies outperform buy-and-hold on a
gross basis, even these authors conclude that their strategies turn unprofitable in the
presence of very modest transactions costs. For example, Sweeney (1988) arguesthat
only floor traders would likely havebeen able to profitably use his 0.5% filter rule, and
Corrado and Lee (1992) concede that one-way transactions costs of just 0.11% and
0.12%, respectively, would eliminate profits accruing to their 0.5% own-stock filter
and 0.25% Standard & Poor’s (S&P) 500 Index filter rules. Several recent studies of
technical trading rules in individual stocks report evenless promise in these strategies.
For example, Szakmary,Davidson and Schwarz (1999) show that own-stock filters or
DMAC rules underperform buy-and-hold in NASDAQ stocks on a gross basis; and,
Marshall, Youngand Rose (2006) report similar findings for candlestick strategies in
Dow Jones Industrial Average stocks.2Based on the previous literature as a whole,
it is fair to say that any evidence that trend-following technical trading rules can be
used by investors to outperform buy-and-holdinvesting strategies in individual stocks
appears underwhelming at best.
In contrast to these findings regarding pure trend-following rules, based on
studies beginning with Jegadeesh and Titman(1993), there is overwhelming evidence
that self-financing momentum strategies, which sort a large cross-section of stocks
based on past returns, take long positions in stocks that have performed relatively
well and short positions in those that have relatively poor past performance, earn
very high returns. This divergence in findings regarding pure trend-following and
momentum strategies in individual stocks is difficult to explain, and provides a key
motivation for our study.
Two recent studies examine trend-following strategies in a momentum
framework in futures markets. Szakmary, Shen and Sharma (2010) examine pure
trend-following and momentum trading strategies using the same long-term, monthly
data set for 28 commodity futures. They show that all of these strategies produce
weak evidence of abnormal returns in individual markets, but verypowerful evidence
1It is now generally accepted that other early studies that do report profitable trading strategies, for
example, Alexander (1961, 1964) and Levy (1967) sufferfrom various methodological problems (such as
failure to include dividends, data-mining, and the use of index data subject to nonsynchronous trading)
that render their conclusions suspect.
2Many other well-known studies, for example, Brock, Lakonishok and LeBaron (1992), Sullivan,
Timmermann and White (1999), Moskowitz, Ooi and Pedersen (2012), as well as many of the recent
stock market studies discussed in the literature review by Park and Irwin (2007),examine the profitability
of technical trading strategies in stock indices or futures and are therefore less directly relevant to our
study, which focuses on individual stocks.
A. C. Szakmary and M. C. Lancaster/The Financial Review 50 (2015) 221–255 223
of abnormal returns, both statistically and economically, when their results are
aggregated across markets. In contrast to most previous studies, they show that the
pure trend-following strategies they examine (e.g., DMACs and channels) generally
perform better than momentum strategies when evaluated in the same context.
Moskowitz, Ooi and Pedersen (2012) evaluate a “time series momentum” strategy
that takes long (short) positions if excess returns relative to a risk-free asset are
positive (negative)over some look-back period, for a broader array of futures markets
that include equity indices, government bonds, and currencies. They similarly find
that the time series momentum strategies perform at least as well as traditional
cross-sectional momentum strategies. They further show that time series momentum
returns have small coefficients on standard risk factors, are highly correlated across
asset classes, and that noncommercial traders in futures markets exploit time series
momentum to earn trading profits at the expense of commercial traders.
The main purpose of our study is to determine whether some of the major findings
of Szakmary, Shen and Sharma (2010), and Moskowitz, Ooi and Pedersen (2012),
also extend to individual U.S. stocks over the 1962–2013 period. Using the entire
CRSP database of NYSE, Amex, and NASDAQ stocks, we show they largely do.
Portfolios formed using technical indicators such as moving average ratios, channels
or past returns relative to a risk-free asset, without employingcross-sectional rankings
of any kind, tend to perform about as well on average as momentum portfolios formed
using cross-sectional ranks when the results are evaluated in a context that is typical
of momentum studies (i.e., formation and holding periods of 6–12 months). Weshow
that when applying price and size screening common in the momentum literature,
both momentum and pure trend-following strategies were profitable in gross terms
prior to 2007 and that returns earned by these strategies were probably in excess of
transactions costs as well. However,we find no evidence that any of the strategies we
examine are profitable post-2007, and show that the market state dependence of these
strategies, while similar to that shown by Cooper, Gutierrez and Hameed (2004) for
momentum, does not fully explain their decline in profitability.
Jegadeesh and Titman (1993) were the first to report momentum profits in the
U.S. stock market. Using a different methodological approach, Conrad and Kaul
(1998), nevertheless, report similar findings. Conrad and Kaul (1998), as well as
Grundy and Martin (2001) show that the momentum strategies work in all subperiods
they examine, being consistently profitable in the U.S. stock market since the 1920s.
Similarly, Jegadeesh and Titman (2001) find that in the 1990–1998 period (which
was not included in their original 1993 paper) momentum strategies continue to
be profitable to about the same degree as earlier; that is, the best strategies earn
abnormal returns of approximately 1% per month in gross terms. Whether these
returns are sufficiently high to overcome the transactions costs associated with the
strategies is not totally clear.Korajczyk and Sadka (2004) find that momentum profits
arising from long positions are robust to direct transactions costs such as brokerage
commissions and bid-ask spreads, but not necessarily to price-impact costs associated
with large-scale trading. Furthermore, Lesmond, Schill and Zhou (2004) assert that

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