The Strategy That Just Rides Whatever Is Trending
Trend following makes no forecast and holds no view. It simply rides prices that are moving and reverses when they stop, which sounds trivial and is surprisingly hard to stick with.
A Strategy With No Opinion
Most investment approaches rest on a view: this company is undervalued, this economy will grow, this currency will weaken. Trend following has no view at all. It observes which prices are moving and bets they will keep moving, buying markets that are rising and shorting markets that are falling.
It is applied across dozens of markets at once, stocks, bonds, currencies and commodities, by funds often called managed futures or CTAs. The strategy makes no forecast about any of them. It reacts to price rather than predicting it.
The trend follower does not know why a market is moving and does not care. The only input is the direction of the price, which is why the strategy can trade markets its managers know nothing about.
How It Works
The mechanics are mechanical by design. A model measures whether each market price is trending up or down over some horizon, and takes a position in the direction of the trend. When the trend reverses, the position is closed and reversed. The rules are systematic and applied identically across every market, removing human judgement from each trade.
| Market behaviour | Position |
|---|---|
| Price rising over the measured horizon | Long |
| Price falling over the measured horizon | Short |
| Trend reverses | Close and flip |
Because it can go short as easily as long, trend following profits from falling markets as well as rising ones, which is central to its appeal.
Winning by Losing Often
The defining feature of trend following is its win rate: it is wrong more often than it is right. Most trends fizzle, and the strategy takes many small losses when a move it followed reverses quickly.
It makes money because the occasional large, sustained trend more than pays for all the small losses. A handful of big moves a year, a commodity that trends for months, a currency that slides steadily, generate gains that dwarf the accumulated small losses from false starts.
This produces a return pattern that is psychologically hard to endure: frequent small losses punctuated by occasional large gains. The discipline required is to keep taking the small losses while waiting for the large winners, which is exactly what most people cannot do, and which is why the strategy is run systematically rather than by discretion.
The Crisis Insurance Property
Trend following has a valuable characteristic: it tends to perform well during sustained market crises, precisely when other strategies suffer. This is sometimes called crisis alpha.
The reason is structural. Major crises usually involve sustained trends, markets falling steadily, safe assets rising steadily, over weeks or months. Trend followers, positioned short the falling markets and long the rising ones, profit from these moves. Because crises produce exactly the kind of sustained trends the strategy is built to capture, it often makes money when a diversified portfolio is losing it.
This makes trend following attractive as a diversifier, not because its standalone returns are always high, but because it tends to be positive when other things are negative.
Why It Struggles
The strategy has a natural enemy: markets that move sideways or reverse sharply without sustained direction. In choppy, range bound conditions, trend following takes loss after loss as it repeatedly positions for trends that immediately reverse.
Long periods of central bank suppressed volatility and range bound markets have been difficult for trend followers, since the sustained trends they need did not appear. The strategy can underperform for years when markets lack direction, which tests the patience of investors who forget that the flat periods are the price of the crisis protection.
There is also the question of decay: as the strategy became widely known and widely traded, some argue the trends it exploits are arbitraged away faster, reducing returns. The counterargument is that trends arise from persistent human behaviour and the slow diffusion of information, which do not disappear because the strategy is known.
The Bottom Line
Trend following holds no view and makes no forecast, mechanically buying rising markets and shorting falling ones across many markets at once. It is wrong more often than right and profits because a few large sustained trends pay for many small losses, a return pattern that is hard to endure and best run systematically. Its greatest value is the tendency to profit during sustained crises, when it offsets losses elsewhere, at the cost of long frustrating stretches when markets lack the direction it needs.