Trend Following Trading Strategies: The Unexpected Profits Hidden in Simplicity

It wasn’t supposed to work. Trend following seemed too simple, too risky, and in many eyes, outdated. But here I was, staring at the numbers, my portfolio showing a steady, almost miraculous rise. The key? A strategy so basic that many investors ignored it outright. Trend following.

It all started with the 2008 financial crisis. While the world watched markets collapse, a small group of traders emerged from the wreckage not just unscathed, but richer. Much richer. Their secret? They weren't trying to predict market tops or bottoms. They simply followed the trend, regardless of which direction it took them.

But why does it work? Why would a strategy as rudimentary as following the direction of the market produce such outstanding results? The answer is embedded in human psychology and market behavior. Markets trend because of mass psychology. Once a price movement starts, it gathers momentum. Fear, greed, and herd mentality push prices further in the same direction until, inevitably, they reverse. But by that time, trend followers are already out, having captured the bulk of the move.

Look at the historical data: Time and again, trends emerge, continue, and end. The great bull market of the 1990s? A trend. The housing bubble and subsequent crash? Another trend. The rise of tech stocks in the 2010s? Yet another. In each case, trend-following traders simply latched onto the movement and rode it for all it was worth.

But don’t be fooled—trend following isn’t a get-rich-quick scheme. It requires patience, discipline, and, most importantly, strict risk management. You won’t win on every trade. In fact, you’ll lose on many. But the key to trend following is that the winners far outweigh the losers. One large trend can more than compensate for multiple small losses.

Consider this simple strategy: Let’s say you decide to go long on a stock that has broken above its 200-day moving average, or short on a stock that has dropped below it. At its core, this is a trend-following strategy. It doesn’t require complex algorithms or deep financial knowledge. But if you stick to it, manage your risk, and follow the rules, it works.

In a way, trend following is counterintuitive to human nature. As humans, we want to believe we can predict the future. We’re drawn to news headlines, economic reports, and market analysis that claim to know what’s going to happen next. But the hard truth is: we don’t know. No one does. The future is unpredictable, and trying to outguess the market is a fool’s game.

Now, let’s take a deeper look at some real-world examples of trend-following success stories:

• The Turtle Traders: This legendary experiment conducted by Richard Dennis in the 1980s proved that anyone, even those without prior trading experience, could become a successful trend follower with the right training and discipline. The group of "Turtles," as they were called, was given a set of simple rules for entering and exiting trades based on market trends. By the end of the experiment, many of them had amassed fortunes, and the results have been studied and emulated by traders ever since.

• Paul Tudor Jones: One of the most famous hedge fund managers in the world, Jones made his fortune by following trends. In 1987, he predicted the market crash, not by divine insight but by recognizing the signs of a massive downtrend. His firm, Tudor Investment Corporation, is still one of the most successful in the world today.

• Bill Dunn: Dunn Capital Management, founded by Bill Dunn, has been using systematic trend-following strategies for over four decades. Through bull markets, bear markets, and everything in between, Dunn's approach has yielded consistent returns, proving the long-term viability of the strategy.

What does this mean for you as an individual trader? The beauty of trend following is that it doesn’t require access to insider information, nor does it demand you to be glued to your screen all day. It works across multiple asset classes—stocks, commodities, currencies, and even cryptocurrencies. The key lies in the discipline to follow the rules and resist the urge to jump in and out of trades based on emotion.

Let’s break down the components of a solid trend-following strategy:

1. Entry signal: The most common entry signal is when the price of an asset crosses above or below a moving average, such as the 50-day or 200-day moving average. This signals the beginning of a new trend.

2. Exit strategy: Knowing when to get out is just as important as knowing when to get in. A common exit signal is when the price crosses back below the moving average, indicating the end of the trend.

3. Position sizing: Don’t risk too much on any single trade. A general rule is to risk no more than 1-2% of your total capital on any given trade.

4. Risk management: Use stop losses to protect yourself from big losses. Trend following is about capturing the large moves, so you want to cut your losses quickly if the trend doesn’t materialize.

Advantages of trend following:

• Simplicity: You don’t need to predict the future; you just follow the current trend.
• Works across different markets: Whether it's stocks, commodities, forex, or crypto, trends exist in every market.
• Time-efficient: Once you’re in a trade, you don’t need to micromanage it. Let the trend do the work for you.

Disadvantages of trend following:

• False signals: Not every trend signal will result in a profitable trade. There will be many false starts, and it can be frustrating.
• Drawdowns: Trend-following strategies often go through periods of drawdown where the strategy isn’t working. This can test the patience and resolve of even the most disciplined traders.

How to mitigate these risks? One way is to trade across multiple markets and asset classes. If a trend isn’t materializing in one area, it might be happening in another. This diversification can smooth out the performance and reduce the impact of drawdowns.

In conclusion, trend following isn’t glamorous. It’s not going to give you the thrill of day trading or the excitement of catching market tops and bottoms. But what it will give you is consistency. Over time, with proper risk management, it’s a strategy that can generate significant returns. The simplicity of the strategy is its strength, not its weakness. Remember, in the world of trading, often the simplest solutions are the most effective.

So next time you find yourself trying to predict where the market is going, stop. Instead, ask yourself: What’s the current trend, and how can I follow it?