Trend following is one of the oldest and most successful trading strategies. The concept is simple: identify the direction of the market and trade in that direction until the trend ends. While it sounds easy, successful trend following requires discipline, patience, and proper risk management.
What is Trend Following?
Trend following is a trading approach that assumes prices will continue moving in their current direction. Key principles include:
- Markets trend more often than they reverse
- Let winners run and cut losers short
- Never predict - only react to what the market shows you
- Accept many small losses for occasional large wins
Key concept: Trend followers do not try to predict tops and bottoms. They accept being late to the party and leaving early, but they capture the meat of major moves.
Why Trend Following Works
Several market dynamics support trend following:
- Economic cycles: Bull and bear markets last for extended periods
- Institutional buying: Large funds take time to build positions, creating trends
- Human psychology: Fear and greed create momentum
- Self-fulfilling prophecy: Many traders following trends amplifies them
Identifying Trends
Higher Highs and Higher Lows
The most basic trend identification:
- Uptrend: Each high is higher than the previous high, each low is higher than the previous low
- Downtrend: Each high is lower than the previous high, each low is lower than the previous low
Moving Average Methods
- Price above the 200 SMA indicates long-term uptrend
- Price above the 50 EMA indicates medium-term uptrend
- 20 EMA above 50 EMA above 200 SMA shows strong uptrend alignment
ADX Indicator
The Average Directional Index measures trend strength:
- ADX below 20: No trend or weak trend
- ADX 20-40: Developing or moderate trend
- ADX above 40: Strong trend
Entry Rules for Trend Following
Moving Average Crossover Entry
- Buy when short-term MA crosses above long-term MA
- Sell/short when short-term MA crosses below long-term MA
- Common combinations: 10/50, 20/50, 50/200
Golden Cross Entry Example
Stock XYZ: 50 EMA crosses above 200 SMA
Price: $45
Entry: Buy at $45.50 on the day after the crossover confirms
Stop: Below the 200 SMA ($42)
Target: Let it run until the trend ends
Breakout Entry
- Buy when price breaks above the highest high of the last 20 days (Donchian Channel)
- Buy when price breaks above a significant resistance level
- Enter on the close of the breakout day
Pullback Entry in Existing Trends
- Wait for an established trend
- Buy when price pulls back to a moving average
- Enter when price shows signs of resuming the trend
Exit Rules for Trend Following
Initial Stop Loss
- Place stop below recent swing low for long trades
- Use ATR-based stops (2-3x ATR from entry)
- Place stop below key moving average
Trailing Stop Methods
The key to trend following is letting winners run with trailing stops:
- Swing low trailing: Move stop below each new higher low
- Moving average trailing: Exit when price closes below the 20 or 50 EMA
- ATR trailing: Trail 2-3x ATR below the highest close
- Percentage trailing: Trail 10-20% below the highest price
Trailing Stop Example
Entry: $50 with initial stop at $47
Price rises to $55: Move stop to $52 (below swing low)
Price rises to $62: Move stop to $58 (below swing low)
Price rises to $70: Move stop to $65 (below swing low)
Price drops to $65: Stopped out with $15 profit per share
Exit Signals
- Moving average crossover in the opposite direction
- Break below key support level
- Trend structure breaks (lower low in an uptrend)
- ADX drops below 20 indicating trend is weakening
Position Sizing for Trend Following
Proper position sizing is crucial since trend following has many small losses:
- Risk 1-2% of account per trade
- Calculate position size based on distance to stop loss
- Diversify across multiple uncorrelated markets
- Never risk more than 6-10% of account total across all positions
The Turtle Trading Rules
The famous Turtle Traders used a systematic trend following approach:
- Buy when price breaks above 20-day high
- Sell when price breaks below 10-day low
- Risk 2% of account per trade
- Use ATR for position sizing
- Add to winning positions (pyramid)
Trend Following Expectations
Understand what to expect with this strategy:
- Win rate: Typically 30-40% (many small losses)
- Win/loss ratio: Large winners offset losses (3:1 or higher)
- Drawdowns: Can be significant during choppy markets
- Performance: Best in trending markets, struggles in ranges
When Trend Following Struggles
- Sideways, choppy markets generate whipsaws
- Quick reversals before stops are hit
- Low volatility environments
- Markets dominated by range-bound trading
Trend Following Checklist
- Is there a clear trend in my timeframe?
- Am I trading in the direction of the trend?
- Do I have a valid entry signal?
- Is my stop loss at a logical level?
- Do I have a trailing stop plan?
- Am I risking an appropriate amount?
Common Trend Following Mistakes
- Taking profits too early instead of letting winners run
- Moving stops too tight and getting shaken out
- Fighting the trend by calling tops and bottoms
- Not accepting the low win rate
- Abandoning the strategy during drawdowns
- Overtrading in choppy markets
Track Your Trend Trades
Pro Trader Dashboard helps you analyze how well you follow trends and whether you let winners run.
Summary
Trend following is a proven strategy that profits by riding sustained market moves. The approach requires patience to wait for trends, discipline to follow the rules, and mental strength to accept many small losses. Success comes from letting winners run with trailing stops while cutting losers quickly. Though it struggles in choppy markets, trend following captures the big moves that drive long-term profitability.
Learn more: pullback trading and moving averages.