A core tenet of trend-following is to diversify. Diversify markets and diversify the signals. The diversification of markets is rather simple. Add uncorrelated markets to reduce overall volatility. The trend signal is diversified by adding different lookback periods. While medium lookback horizons usually perform best, research has shown that adding short- and long-term signals diversifies the signal set and reduces volatility.
The paper, “Revisiting the strtcuture of trend premia:When diversification hides redundancy,” looks at the trend horizon signal more closely and finds that you can add too many signals. Specifically, if you employ both short- and long-term signals, you will likely render the mid-horizon signals redundant. Do not weight signals equally; use some optimization to balance across horizons. When optimization is employed, the mid-range is not useful, and a barbell approach is better. This is not the conventional wisdom often used when diversifying time horizons. A short horizon helps mitigate drawdowns, and diversifying horizons smooths returns across different regimes. The key issue is determining how many horizons are necessary, given that trend horizons are correlated. However, simple optimization does not seem to add value. The data needs to be examined more closely and manipulated.
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