A question that has been left unanswered for centuries. Does trend-following give a trader an edge?
Is a solution out there? How do we answer this question? In order to find an answer, I chose to use The Intra-Day Momentum Method Levels as a starting point for the solution. The goal was not to specifically define a trend but to demonstrate mathematical solutions.
Solving the Problem
I will go through two mathematical demonstrations to show that trend following is likely to give a trader an edge. In doing so, it is also likely to decrease risk.
The first goal is to see if the High of the day were greater than the ML1 Level. Would that increase the percentage of a close at or above the ML1 level? This way, I am not actually defining a trend. However, I am saying that it starts with a .01 move above the ML1 Level. The goal is to perform the same analysis with the MS1 Level. Find out if a low below the MS1 Level would increase the percentage of a close at or below MS1.
The graphic above shows that a High greater than ML1 would increase the percentage of success from the ML1 Level. This increase was .6% from 49.5% to 50.1%. It also shows the same results if the Low is less than the MS1 Level. The increase was .6% from 47.2% to 47.8%. These calculations do not prove but mathematically demonstrates a probable solution.
Using the Extended Levels to Help Solve the Problem
I chose to find out what percentage of the time a stock reached the next level (ML2/MS2). In the following graphic, the extended levels are reached less than 50% of the time. If a stock were not an intra-day reversal they were reached 43% (ML2) and 44% (MS2) of the time.
The goal was to find a calculation where the next level was reached at least 50% of the time. If a new level can be created that once reached increases the percentage of the time the next level is reached it would demonstrate that trend following would likely give a trader an edge. I took the distance from ML1 to the Open and multiplied that by 1.33. This distance was added to the Open to create a new level. It was also subtracted from the Open to create a new level.
The increase in the percentage of time the next level was reached was considerably higher. This new level, if reached increases the percentage of time that the ML2 is reached by at least 10%. The same thing happened to the downside. If the new level is reached, the percentage of time the MS2 level is reached was increased by at least 10%.
In conclusion, I have demonstrated mathematically that trend following would likely give a trader an edge. I have shown that an increase in price in the direction of the trend increases the probability of a close in that direction. I have also demonstrated by creating a new level, that if it is reached, the probability of reaching an extended level increases.