This research paper, published in the Fall 2017 issue of the Journal of Alternative Investments, uncovers the return-weighting schemes implied by conventional price-moving averages, which are widely-used indicators in technical analysis. The study of these return weights reveals useful and sometimes surprising aspects of trend rules. All of these aspects are hidden by their specifications in terms of prices but are revealed by the analysis of return weights. We argue that having a better understanding of these trend rules allows us to further improve these rules.
For example, using the return weights, it is possible to analyze the trend and mean-reversion parts of the popular moving-average convergence divergence (MACD) rule separately, and it allows one to assess the impact of the implied mean reversion in combinations of multiple moving-average rules. If the mean-reversion part contributes negatively to the performance of the trend rule, one can only keep the positive return weights, leading to an improved trend rule without the mean-reversion part. Because of the greater transparency of trend rules based on returns, we advocate designing trend rules based on returns rather than prices.
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