Trend Following Trading under a Regime Switching Model

M. Dai, Q.Zhang and Q. J. Zhu

Abstract:This paper is concerned with the optimality of a trend following trading rule. The idea is to catch a bull market at its early stage, ride the trend, and liquidate the position at the first evidence of the subsequent bear market. We characterize the bull and bear phases of the markets mathematically using the conditional probabilities of the bull market given the up to date stock prices. The optimal buying and selling times are given in terms of a sequence of stopping times
determined by two threshold curves. Numerical experiments are conducted to validate the theoretical results and demonstrate how they perform in a marketplace.


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