What is trend-following?
Trend-following is a trading strategy that aims to capitalize on market trends. Instead of predicting the future direction of the market, traders who adopt this strategy simply seek to identify and follow existing trends, whether up, down or sideways.
The beauty of trend-following lies in its simplicity. The strategy is based on the assumption that trends, once established, tend to persist. Consequently, a trader using this strategy will seek to enter the market when a new trend is identified, and stay there until signs of reversal appear.
How Trend-following works
To determine whether a trend is underway, traders often rely on technical analysis. This method involves examining price charts to identify past price movements and predict future ones. Among the most commonly used tools for this analysis are moving averages.
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Moving averages
The simplest and most common indicator is the moving average. This tool takes price data over a specific period and creates a smooth line representing the average price of the asset over that period. When current prices are above this average, this may indicate an upward trend, and vice versa.
Other indicators
Other popular tools include the RSI (Relative Strength Index) oscillator and MACD (Moving Average Convergence Divergence). These tools can help traders identify the strength and direction of a trend.
Trend-following advantages and disadvantages
Advantages
- Simplicity: Trend-following is relatively simple to understand and implement, especially with modern technical analysis tools.
- Effectiveness: When used correctly, trend-following can be highly profitable, especially in strongly trending markets.
Disadvantages
- False signals: Like all trading strategies, trend-following is not infallible. There may be times when indicators suggest a trend that doesn't materialize.
- Lag: Trend-following tools can sometimes lag behind the market, which means traders may enter or exit a position too late.
Trend-following in the context of algorithmic trading
With the rise of algo trading, trend-following has gained in popularity. Algorithms can be programmed to recognize and capitalize on trends much faster than humans. What's more, algorithms can analyze massive volumes of data in real-time, making them extremely effective for trend-following.
Conclusion
Trend-following is a proven trading strategy that, when used correctly, can deliver impressive returns. While nothing guarantees success in the world of trading, following trends and using the right tools can greatly increase your chances of success. For those looking to delve into the exciting world of algo trading, trend-following is a strategy to be seriously considered.
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