Long Term Trend Following

Long Term Trend Following

Long Term Trend Following (LTF) is a quantitative trading strategy that aims to profit from sustained price trends in financial markets. It's a systematic approach relying on identifying and capitalizing on these trends, often holding positions for weeks, months, or even years. Unlike day trading or swing trading which focus on short-term fluctuations, LTF focuses on the "big picture" and aims to capture the majority of a trend’s move. This article provides a comprehensive overview of LTF for beginners, covering its principles, mechanics, risk management, and common pitfalls.

Core Principles

The fundamental belief behind LTF is that trends exist and persist for longer than most traders anticipate. This is rooted in behavioral finance, where factors like herding, slow information dissemination, and cognitive biases contribute to price momentum. LTF strategies assume that what happened *yesterday* (and the days before) has a higher probability of continuing *tomorrow* than a random walk would suggest.

Key principles include:

Trend Identification: Accurately identifying the presence and direction of a trend is paramount. This is achieved through Technical Analysis and the use of various indicators.
Systematic Rules: LTF is not discretionary. Entry and exit rules are predefined and based on objective criteria. This removes emotional biases.
Position Sizing: Properly scaling position sizes based on market volatility and risk tolerance is crucial for capital preservation. Kelly Criterion offers a theoretical approach to optimal bet sizing, although often modified in practice.
Patience and Discipline: LTF requires patience as trends can take time to develop and mature. Discipline is essential to stick to the system, even during drawdowns.
Diversification: Spreading capital across multiple uncorrelated markets reduces overall portfolio risk. Correlation analysis is a key component of diversification.
Acceptance of Drawdowns: LTF systems inevitably experience periods of losses (drawdowns). Understanding and preparing for these is critical. Maximum Drawdown is a key metric to monitor.

How Long Term Trend Following Works

LTF typically involves the following steps:

1. Universe Selection: Define the markets to be traded. This could include:

   *   Commodities:  Crude Oil, Gold, Silver, Natural Gas, Agricultural Products – these often exhibit strong, long-lasting trends.  See Commodity Channel Index for trend identification.
   *   Currencies (Forex): Major currency pairs (EUR/USD, GBP/USD, USD/JPY) and potentially crosses.
   *   Stock Indices:  S&P 500, Nasdaq 100, Dow Jones Industrial Average, FTSE 100 – represent broad market trends.
   *   Bonds: US Treasury Bonds, Corporate Bonds – can offer trends, though often less volatile.
   *   Interest Rate Futures:  Reflect expectations about future interest rate changes.

2. Trend Identification (Indicators): Employ technical indicators to identify trends. Common indicators include:

   *   Moving Averages: Simple Moving Average (SMA), Exponential Moving Average (EMA). Crossovers are frequently used as entry signals.  Learn more about Moving Average Convergence Divergence (MACD).
   *   Donchian Channels: Identify highs and lows over a specified period. Breakouts can signal trend initiation.
   *   Average Directional Index (ADX): Measures the strength of a trend, regardless of direction.  An ADX value above 25 generally indicates a strong trend. Investopedia ADX
   *   Parabolic SAR:  Places dots above or below price to indicate trend direction.
   *   Ichimoku Cloud: A comprehensive indicator providing support/resistance levels, trend direction, and momentum signals.  School of Trade Ichimoku Cloud

3. Entry Rules: Define specific conditions that trigger a trade. Examples:

   *   Moving Average Crossover:  Buy when a short-term moving average crosses above a long-term moving average.
   *   Breakout: Buy when the price breaks above a defined resistance level (e.g., Donchian Channel high).
   *   Indicator Signal: Buy when an indicator (e.g., MACD) generates a bullish signal.

4. Exit Rules: Establish rules to close a trade. These are just as important as entry rules.

   *   Trailing Stop Loss:  Adjust the stop-loss level as the price moves in your favor, locking in profits.
   *   Reverse Signal:  Sell when the indicator that triggered the entry signal generates a bearish signal.
   *   Time-Based Exit:  Close the trade after a predetermined period, regardless of profit or loss.
   *   Volatility-Based Exit:  Exit when volatility reaches a certain level (e.g., using Average True Range - ATR). ATR on BabyPips

5. Position Sizing: Determine the appropriate amount of capital to allocate to each trade. Consider:

   *   Fixed Fractional: Risk a fixed percentage of capital on each trade (e.g., 1-2%). This is a common approach.
   *   Volatility Adjustment: Reduce position size when market volatility is high and increase it when volatility is low.  Using Bollinger Bands can help assess volatility.
   *   Kelly Criterion (Modified): Use a fraction of the Kelly Criterion to optimize position sizing.

6. Risk Management: Implement measures to protect capital.

   *   Stop-Loss Orders:  Essential for limiting potential losses.
   *   Diversification:  Across markets and timeframes.
   *   Position Limits:  Limit the maximum exposure to any single market.

Examples of Long Term Trend Following Systems

Dual Moving Average Crossover: This classic system uses two moving averages (e.g., a 50-day SMA and a 200-day SMA). Buy when the 50-day SMA crosses above the 200-day SMA, and sell when it crosses below. Fidelity Moving Average Crossover
Donchian Channel Breakout: Buy when the price breaks above the upper Donchian Channel and sell when it breaks below the lower channel.
Turtle Trading System: Developed by Richard Dennis and William Eckhardt, this system uses breakout strategies and position sizing based on volatility. Investopedia Turtle Trading
Managed Futures: A broader category encompassing LTF strategies, often implemented by Commodity Trading Advisors (CTAs). CFA Institute Managed Futures

Risk Management in Long Term Trend Following

Effective risk management is absolutely vital for success in LTF. Here's a breakdown of key considerations:

Drawdowns: LTF systems will inevitably experience drawdowns – periods of losses. Prepare for these emotionally and financially. Understand your risk tolerance. CFI Drawdown
Stop-Loss Orders: Use stop-loss orders on *every* trade. Determine the appropriate stop-loss level based on market volatility and your risk tolerance. Consider using ATR-based stop-losses.
Position Sizing: The most important risk management tool. Never risk more than a small percentage of your capital on any single trade.
Diversification: Trade multiple uncorrelated markets to reduce overall portfolio risk.
Correlation Analysis: Understand the correlations between the markets you are trading. Avoid over-exposure to highly correlated assets.
Backtesting & Walk-Forward Analysis: Thoroughly backtest your system on historical data and perform walk-forward analysis to assess its robustness. QuantConnect Backtesting
Stress Testing: Simulate extreme market scenarios (e.g., black swan events) to assess the system’s resilience.

Common Pitfalls to Avoid

Over-Optimization: Optimizing a system too closely to historical data can lead to poor performance in live trading (curve fitting).
Emotional Trading: Sticking to the system is crucial. Avoid making impulsive decisions based on fear or greed.
Ignoring Risk Management: Neglecting risk management is the fastest way to blow up your account.
Underestimating Drawdowns: Be prepared for significant drawdowns. Don't panic and abandon the system prematurely.
Chasing Trends: Entering a trade *after* a trend has already made a significant move can reduce potential profits and increase risk.
Lack of Diversification: Concentrating capital in a single market increases vulnerability to market-specific events.
Data Mining Bias: Finding patterns in historical data that are purely coincidental and not predictive of future performance.

Tools and Resources

Trading Platforms: MetaTrader 4/5, TradingView, NinjaTrader, MultiCharts.
Backtesting Software: Amibroker, TradeStation.
Data Providers: Refinitiv, Bloomberg, IQFeed.
Books: "Trend Following" by Michael Covel, "New Market Wizards" by Jack Schwager.
Websites: Investopedia, BabyPips, StockCharts.com. Options Trading IQ
Indicators: [[Rate of Change (ROC)], [Williams %R], [Fibonacci Retracements], [Stochastic Oscillator]].

Conclusion

Long Term Trend Following is a powerful trading strategy that can generate significant profits over time. However, it requires discipline, patience, and a strong understanding of risk management. By following the principles outlined in this article and avoiding common pitfalls, beginners can increase their chances of success in the world of LTF. Remember to continuously learn, adapt, and refine your system based on market conditions and your own trading experience. Algorithmic Trading can automate many aspects of LTF. Market Sentiment is another factor to consider alongside technical analysis. Volatility Skew can also influence trend strength.

Start Trading Now

Sign up at IQ Option (Minimum deposit $10) Open an account at Pocket Option (Minimum deposit $5)

Join Our Community

Subscribe to our Telegram channel @strategybin to receive: ✓ Daily trading signals ✓ Exclusive strategy analysis ✓ Market trend alerts ✓ Educational materials for beginners