Trend Following
Identify the prevailing direction and ride it. The premise — trends persist longer than most expect, and a few large winners pay for many small losers.
Thesis
Trends in financial markets persist longer than most participants expect. Information diffuses gradually, capital rotates slowly, and behavioral biases like anchoring and herding extend moves well past their “fair value.” By identifying directional pressure early and holding through normal volatility, trend followers aim to capture the bulk of the move while accepting that many entries will fail in chop.
Entry Rules
- Confirm a trend on the higher timeframe (daily or weekly): clear sequence of higher highs and higher lows for longs, the inverse for shorts.
- Wait for a pullback to a moving average (commonly the 20 or 50 EMA) or to prior trend support.
- Enter on a continuation signal — a reversal candle (hammer, bullish engulfing) or a break of short-term consolidation in the trend’s direction.
Exit Rules
- Trailing stop below the most recent swing low (longs) or above the most recent swing high (shorts).
- Alternatively, exit on a daily close below a defined moving average.
- Some trend followers exit on confirmed structural break — a lower high after a series of higher highs.
When It Works
- Markets with sustained directional moves: post-Fed rate cycles, commodity squeezes, sector leadership rotations.
- After significant macro catalysts that take months to fully price in.
When It Fails
- Range-bound, choppy markets where every “trend” reverses within days.
- High-volatility news environments where moves whipsaw.
- Quiet, low-conviction periods (often summer in equity markets).
Common Mistakes
- Trading “trends” on too low a timeframe — five-minute trends are mostly noise.
- Setting stops too tight and getting shaken out of valid moves on normal pullbacks.
- Holding past clear reversal signals out of attachment to the original thesis.
- Confusing a healthy pullback within a trend for the start of a reversal.