Optimal trend-following with transaction costs

Despite the widespread popularity of trend-following investing, optimal trend-following in the presence of transaction costs remains poorly understood. Existing studies on the subject are limited and rely on intricate theoretical models, posing great challenges in practical applications. In this paper, we propose a new, more pragmatic model that balances theoretical simplicity and practical relevance. Under plausible assumptions regarding the trend dynamics, we establish a noteworthy resemblance between the optimal trend-following strategy and the well-known simple moving average crossover rule. Consequently, our model provides a compelling rationale for the practical adoption of crossover rules. We also perform historical simulations that demonstrate the effectiveness of our model, supporting our theoretical findings. In short, our paper provides a practical and effective solution to the problem of optimal trend-following with transaction costs.