Trend following
Trend following assumes that prices which have moved strongly in one direction tend to keep moving that way for longer than a random walk would suggest. The strategy does not forecast; it reacts.
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Core idea
A trend follower buys after prices have already risen and sells after they have already fallen. Entries are late by design. The edge, where it exists, comes from a small number of very long moves that pay for many small losing trades.
A classic rule set: moving-average crossover
The simplest version compares a fast and a slow simple moving average (SMA) of closing prices.
SMA(n) = (Pt + Pt-1 + … + Pt-n+1) / n- Long signal: the 50-day SMA crosses above the 200-day SMA (often called a "golden cross").
- Exit or short: the 50-day SMA crosses below the 200-day SMA (a "death cross").
Exponential moving averages (EMA) react faster because recent prices get more weight. Faster averages mean earlier signals and more false ones.
Breakout variant
The Donchian channel approach buys when price closes above the highest high of the last N days (20 and 55 are common) and exits on a close below the lowest low of a shorter window. It was popularised by the "Turtle" traders in the 1980s.
What it looks like in practice
| Property | Typical outcome |
|---|---|
| Win rate | Low, often 30–45% |
| Average win vs. average loss | Wins several times larger than losses |
| Best conditions | Persistent macro moves, commodity cycles, crises |
| Worst conditions | Range-bound, choppy markets with frequent reversals |
Common mistakes
- Optimising the averages to fit one instrument's history. A rule that only works with 47 and 183 days is probably curve-fitted.
- Abandoning the system during the long flat periods that are a normal part of its return profile.
- Ignoring position sizing. Most professional trend systems scale position size by volatility; see risk management.
Further reading
Michael Covel, Trend Following; Andreas Clenow, Following the Trend; Moskowitz, Ooi and Pedersen, "Time Series Momentum" (Journal of Financial Economics, 2012).
Practice
Three quick tasks. Pick an answer to check it, or open the answer below each task.
The 50-day SMA is 104 and the 200-day SMA is 101, and yesterday the 50-day was below the 200-day. What is the signal?
Show answer
Golden cross: go long. The fast average crossed above the slow one, the classic long entry.
A trend system wins 35% of trades. Can it still be profitable?
Show answer
Yes, if average wins are much larger than average losses. Expectancy = 0.35 x avg win - 0.65 x avg loss. With wins about 3x losses it is positive.
In which market does trend following usually struggle?
Show answer
A sideways, choppy range. Frequent reversals trigger many small losing trades.
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