Separating Futures Tradings Trend Filter

Following the trend in futures trading is essential to exploiting the trend component of market price action, successful systems and approaches employ some method of identifying trend. A popular idea is a separate trend filter. This is an algorithm that preliminarily looks at recent price action and determines the trend.

It is not essential that every approach have a separate trend filter. Some methods, such as moving averages, incorporate a trend indicator into the entry technique. Others try to predict an imminent change in trend and are therefore entering when the trend is against them at the time.

A lot of traders make the trend identification complicate. They invent all kinds of fancy mathematical equations and methods of massaging past price action to more precisely determine the trend. However, just like all things in trading, simplicity is the best route, this is pointless.

Of course, trend is only relevant in conjunction with a particular time frame. But once you identify the time frame, it is not fancy about the concept of trend. The price is either moving up or it is moving down during that time period. You can look at a chart and in most cases quickly determine whether price is moving up or down in your time frame. Why should it be any more complicated than that? Perhaps in cases of price congestion, it is slightly more difficult to say with certainty what the trend is by quickly looking at a chart. However, this is no reason to unnecessarily complicate the trend determination process.

In creating simple trend indicators, there is one intriguing issue. What price components should you use to construct the indicator? There are four choices: the open, high, low and close. You could use them separately or in combination. Can research help determine whether one or more price components does a better job of indicating trend than the others? Or are they all equivalent in trend-identifying ability?

The procedure is to create four simple trend filter indicators. Each will use different price components. To test their effectiveness, I created for each a simple trading system. When the trend filter is pointing up, the system goes long. It holds the position until the trend filter reverses to down. At that point the system closes out the long position and establishes a short position. The system continues to trade that way. It is always in the market and always positioned in the direction of the trend filter. In order to make the system test as realistic as possible, I deducted $100 from each trade to cover slippage and commission. Theoretically, the filter that is most effective in determining trend should yield the highest profits as a trading system.

Ten diversified markets over a ten- year period were tested. They are: Cattle, Sugar, Soybeans, Swiss Francs, Comex Gold, T-Bonds, Japanese Yen, Heating Oil, Eurodollars and the S&P 500.

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