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Trend following is one of the oldest and most enduring systematic trading strategies. It operates on the premise that once a price trend is established, it is more likely to continue than to reverse. Trend followers aim to capture the large, sustained moves that occur in all markets, accepting that the majority of their trades will be small losers. The strategy has been practiced by commodity trading advisors (CTAs) for decades and has demonstrated positive returns across equities, bonds, currencies, and commodities over multiple generations.
The most common trend following signals are moving average crossovers and channel breakouts. A moving average crossover system goes long when a short-term average crosses above a long-term average and goes short (or exits) when it crosses below. A channel breakout system (often associated with the Turtle Traders) goes long when price exceeds the highest high of the past N days and exits when price falls below the lowest low of the past M days. Both approaches are simple to implement and remarkably robust across markets and time periods.
Position sizing in trend following typically uses volatility-based methods, most commonly the Average True Range (ATR). Each position is sized so that a one-ATR move against the position results in a fixed loss (typically 0.5-2% of portfolio equity). This equalizes the risk contribution of each position regardless of the price level or volatility of the underlying market. The Turtle Trading system, for example, defined one "unit" as a position size that would move portfolio equity by 1% for a one-ATR move.
The return distribution of trend following strategies is highly distinctive. The majority of trades (often 60-70%) are small losses or breakeven, with profits coming from a small number of large winning trades. This creates a positively skewed return distribution with a low win rate but a high profit factor. Psychologically, this is difficult for many investors to tolerate because it involves long stretches of small losses punctuated by infrequent but significant gains. Systematic discipline and trust in the statistical edge are essential.
Trend following strategies tend to exhibit "crisis alpha," performing well during extended market dislocations. During the 2008 financial crisis, many CTA strategies generated strong positive returns by holding short positions in equities and long positions in bonds as trends persisted. Similarly, trend followers profited during the 2022 rate-hiking cycle by holding short bond and long commodity positions. This crisis alpha property makes trend following a valuable portfolio diversifier, as its strongest performance tends to coincide with the worst periods for traditional stock-bond portfolios.