The following system is a very basic and simple trend following system. Its purpose is to show that a simple trend following approach is valid. This system meets all the criteria of being robust. Specifically, it has a small number of rules and those rules are identical for each market tested. Furthermore the system has been tested across virtually every tradable commodity (over 65 futures markets) over a long period of time (roughly 36 years). It goes both long and short and uses the same rules for both (the short rules are simply an inverse of the long rules). By using such a robust method we have minimized the potential for curve fitting (curve fitting is the process of over fitting past data which has little predictive value in the future).

For those of you experienced at developing trading systems you might find this system pretty basic and familiar. However, the point here is not to offer the best trend following system (there are many that are better) but rather to prove that markets do in fact trend and that it’s possible to make money using trend following approaches.

The ingredients that make up the system include daily price data, a moving average, and volatility measurements. These ingredients combined in a very simple fashion show an average yearly gain of over 25% with similar risk. Of course depending on the amount of leverage used you could ramp returns up much higher but it would come with correspondingly increased risk.

Let's now look at both the rules and the results of the system.

First the paraphrased rules (specific code available on request):

• Buy the market at today's opening price if yesterday's close was greater than yesterday's 80 day moving average +2 units of volatility.
• Exit your long position when yesterday's close is below yesterdays 80 day moving average.
• Sell the market at today's opening price if yesterday's close was less than yesterday's 80 day moving average -2 units of volatility.
• Exit your short position when yesterday's close is above yesterdays 80 day moving average.
• Risk no more than 1% of your equity per trade. Risk is calculated as three units of volatility.
• Risk no more than 3% of account equity in any given sector and risk no more than 10% of account equity overall.
• If risk in any given market grows to exceed 2% of account equity cut position size in half.

Let's now take a look at how this extremely simple trend following system performed.

Click here for the system testing results: http://tinyurl.com/mho5ql

Once again, I personally would not trade system because I think there are many that are better. However the purpose of this test was merely to set a baseline that trend following works. It should also be noted that this system has outperformed (at least in testing) many of the biggest Commodity Trading Advisors in the business. There are good discussions about why this is the case. I look forward to any discussions about this trend following system or any other trend following system. I will be posting additional systems as time goes by.

Sincerely,
Dean Hoffman

CFTC REQUIRED RISK DISCLOSURE

HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM.

ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.