Trend Following

Definition from Wikipedia, the free encyclopedia

Trend following is an investment or trading strategy which tries to take advantage of long, medium or short-term moves that seem to play out in various markets. Traders who employ a trend following strategy do not aim to forecast or predict specific price levels; they simply jump on the trend (when they perceived that a trend has established with their own peculiar reasons or rules) and ride it. These traders normally enter in the market after the trend "properly" establishes itself, betting that the trend will persist for a long time, and, for this reason, they ignore the initial turning point profit. A market "trend" is a tendency of a financial market price to move in a particular direction over time. If there is a turn contrary to the trend, they exit and wait until the turn establishes itself as a trend in the opposite direction. In case their rules signals an exit, the trader exits but re-enters when the trend re-establishes.

Cutting Loss. Exit market when market turn against them to minimize losses, and "let the profits run", when the market trend goes as expected until the market exhausted and reverses to book profit.

This trading or "betting with positive edge" method involves a risk management component that uses three elements: 

1. number of shares or futures held, 
2. the current market price, 
3. and current market volatility. 

An initial risk rule determines position size at time of entry. Exactly how much to buy or sell is based on the size of the trading account and the volatility of the issue. Changes in price may lead to a gradual reduction or an increase of the initial trade. On the other hand, adverse price movements may lead to an exit for the entire trade.

If there is a turn contrary to the trend, these systems signal a pre-programmed exit or wait until the turn establishes itself as a trend in the opposite direction. In case the system signals an exit, the trader re-enters when the trend re-establishes.

In the words of Tom Basso, in the book Trade Your Way to Financial Freedom

“ Let's break down the term Trend Following into its components. The first part is "trend". Every trader needs a trend to make money. If you think about it, no matter what the technique, if there is not a trend after you buy, then you will not be able to sell at higher prices..."Following" is the next part of the term. We use this word because trend followers always wait for the trend to shift first, then "follow" it”

Considerations

1. Price: One of the first rules of trend following is that price is the main concern. Traders may use other indicators showing where price may go next or what it should be but as a general rule these should be disregarded. A trader need only be worried about what the market is doing, not what the market might do. The current price and only the price tells you what the market is doing.
2. Money management: Another decisive factor of trend following is not the timing of the trade or the indicator, but rather the decision of how much to trade over the course of the trend.
3. Risk control: Cut losses are the rule. This means that during periods of higher market volatility, the trading size is reduced. During losing periods, positions are reduced and trade size is cut back. The main objective is to preserve capital until more positive price trends reappear.
4. Rules: Trend following should be systematic. Price and time are pivotal at all times. This technique is not based on an analysis of fundamental supply and demand factors.