Trend Is Your Friend. But Sometimes It’s Enemy.

Topics: Quantitative Trading Strategies, Lars Kestner, Market Wizards, Trend following

Trend is your friend, so they say

If you have looked for some trading advice in books or on the internet, you have probably come across the phrase “Trend is your friend”. This is one of the most widely accepted (and most widely reproduced) pieces of trading wisdom. Its core idea is that (in the long run and with a sample of many trades) you have a much better chance for a profit if you take positions in the direction of the current trend in the market.

Trend following

A whole big group of quantitative trading strategies is based on this idea – these strategies are being referred to as trend following. Some big funds base their strategies on the trend following concept. If you have read the first Market Wizards book this is what many of the heroes (like Ed Seykota or Michael Marcus) were doing.

People who like trend following are usually convinced that it is extremely difficult (some even say impossible) to exactly time the turning points in a market and therefore it is better not to try at all and to grab pieces of trend moves instead.

In reality, picking turning points is really not easy. But this doesn’t mean that riding trends is a piece of cake. If it was, Market Wizards would have been much thicker, or (more likely) the book would not have been written at all.

The problem with trend following: sometimes it doesn’t work

Like other things in trading and finance, the trend following idea is sometimes right and sometimes it is less right. The reason is that markets’ eagerness to make long trend moves varies over time and across markets.

Some markets move in trends more often than others. While on crude oil or stocks you have nice trending action almost all the time, on stationary vehicles like the VIX (index of implied volatility of options) you need a once-in-a-century credit crisis in order to see something that resembles a trend. Besides, one particular market may show nice clean long trend now and go totally sideways tomorrow. You never know.

Should I be a trend follower?

As you would expect from the paragraph above, the answer is It depends. It depends on many factors, most importantly on the markets you trade, the time horizon you focus on, and (not least) whether you would actually enjoy and be comfortable with a trend following strategy. Sometimes it is just frustrating to take the seventh little loss in a row before your big home run comes.

In some interviews in the above mentioned Market Wizards there are a few interesting discussions about whether trend following works and why, and if it will still work when more people will be doing it.

You can also read some nice remarks and rough backtests of various quantitative strategies (not limited to trend following tools) in Lars Kestner: Quantitative Trading Strategies – Chapter 7: Dissecting Strategies Currently Available: What Works and What Doesn’t.

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Topics: Quantitative Trading Strategies, Lars Kestner, Market Wizards, Trend following