The paper, “Is Trend Still Your Friend: A microstructural account of the demise of short-term trend-following”, is important research on why trend-following may not work over short horizons. While trend-following seems to span time, there are exceptions. Since 2009, there has been no profit to be had from short-term trend trading. This paper documents the break in short-term trend trading and finds a reasonable explanation.
The paper tests four different explanations: 1. capacity constraints, 2. market electrification, 3. a change in CTA order flow interactions, and 4. microstructural changes. The authors find that the first three cannot explain the differences, but the volatility-normalized tick size can explain the change in profits. The trend profits fell on small-tick contracts but remain intact for large-tick contracts. Trend signals trigger directional trades. The market impact of these trades reinforces price movement. This feedback loop requires aggressive execution at reasonable costs, but it also causes market makers to withdraw from the trend, especially for small-tick contracts. Trend-following becomes unprofitable. Stick with the large ticks if you want to trade short-term.
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