Trend Following Returns

Trend Following Returns

Once we have a momentum signal, we can compute the strategy's returns. The idea is simple: trade in the direction of the signal, entering positions based on the prior day's signal.

Algorithm

For each day t from 1 to len(prices) - 1:

1. Compute the daily return: daily_ret = prices[t] / prices[t-1] - 1
2. Read the signal from the previous day: sig = signals[t-1]
3. Strategy return: sig * daily_ret

This means:

• If the signal was 1 (long), we earn the daily return.
• If the signal was -1 (short), we earn the negative of the daily return.
• If the signal was 0 (flat), we earn nothing.

The result list has length len(prices) - 1.

Task

Implement trend_returns(prices, lookback) using the momentum signal from the previous lesson.