TL;DRTrend following uses moving averages to identify the market's direction and enters trades in that direction on pullbacks. The most common approach uses the 20-period and 50-period moving averages on a 5-minute or daily chart. Win rates are typically 35-45%, but the average win is 2-3x larger than the average loss, producing positive expectancy over time.
Trend following is the oldest and most researched trading strategy. The premise is simple: identify the direction the market is moving (the trend), position yourself in that direction, and hold until the trend ends.
Moving averages are the most common tool for identifying trends. When price is above a moving average, the trend is up. When price is below, the trend is down. When a shorter moving average crosses above a longer one, a new uptrend may be starting. The reverse signals a potential downtrend.
Trend following accepts that you cannot predict where the market will go. Instead, you react to what it's doing. You enter after the trend has started (you miss the beginning) and exit after it has ended (you give back some profit at the end). The money is made in the middle.
Choose your moving averages. The most common combinations are: 9 EMA and 21 EMA for aggressive scalping/day trading. 20 SMA and 50 SMA for standard day trading. 50 SMA and 200 SMA for swing trading and position trading.
Define the trend. Price above both moving averages with the shorter MA above the longer MA = uptrend. Price below both MAs with the shorter below the longer = downtrend. Price between the MAs or MAs tangled together = no trend (stay out).
Entry on pullbacks. In an uptrend, wait for price to pull back to the shorter moving average. This is your entry zone. The moving average acts as dynamic support. Enter when price touches or gets within a few ticks of the MA and shows a bounce.
Stop loss. Place your stop below the longer moving average in an uptrend or above it in a downtrend. This gives the trend room to breathe while providing a clear invalidation point. If price breaks through the longer MA, the trend has changed.
Trailing stop. Trend following works best with trailing stops rather than fixed targets. As price moves in your favor, trail your stop to the shorter moving average. This lets you ride trends for their full extent without guessing where they'll end.
Trend following strategies typically win 35-45% of the time. This sounds bad until you look at the math.
When you're wrong, you lose a small, controlled amount (the distance from your entry to your stop). When you're right, you ride the trend and make a multiple of that amount. If your average loss is $300 and your average win is $800, you only need to win 28% of the time to break even.
At a 40% win rate with $300 average loss and $800 average win: expectancy per trade = (0.40 x $800) - (0.60 x $300) = $320 - $180 = $140 profit per trade. Over 100 trades, that's $14,000.
The psychological challenge is enduring losing streaks. Seven losses in a row is statistically normal with a 40% win rate. Most traders abandon the strategy after 4-5 losses and miss the big winner that would have made up for all of them.
Trend following is a strategy of patience and discipline. The edge is in the asymmetry of wins vs losses, not in being right more often than you're wrong.
Trend following produces the largest profits during strong directional moves. Major Fed policy shifts, economic surprises, and secular trends (like the 2020-2021 bull market or the 2022 rate-hike selloff) are where trend followers make the bulk of their returns.
The strategy works well on higher timeframes (daily and weekly charts) for swing trading. Intraday trend following works too, but requires more active management and produces smaller per-trade profits.
Trend following fails in choppy, range-bound markets. When price oscillates around the moving averages with no direction, every entry gets stopped out and the strategy produces a string of small losses. This is called a whipsaw environment.
The worst periods for trend following are transitions from trending to range-bound markets. The trend ends, the strategy gives back profits on the reversal, and then produces losses during the subsequent chop before a new trend emerges.
On the ES daily chart, the 20 SMA is at 5,180 and the 50 SMA is at 5,140. Price is at 5,210. Both MAs are sloping upward with the 20 above the 50. This is a confirmed uptrend.
ES pulls back over three days from 5,230 to 5,185, reaching the 20 SMA. On the fourth day, ES prints a hammer candle at 5,182 (touching the 20 SMA) and closes at 5,195.
Entry: buy at 5,196 (above the hammer close). Stop: 5,138 (below the 50 SMA, 58 points, $2,900 per contract). This is a swing trade, so use MES for smaller accounts (58 points = $290 per MES contract).
Trailing stop: as the trend resumes, move your stop to below the 20 SMA. After two weeks, price reaches 5,280. The 20 SMA has risen to 5,230. Your trailing stop is now at 5,228, locking in 32 points of profit.
ES eventually breaks below the 20 SMA at 5,245, hitting your trailing stop at 5,240. Total gain: 44 points ($2,200 per ES, $220 per MES). The risk was 58 points, the reward was 44 points, which is a sub-1:1 ratio on this specific trade. But the prior 3 pullback entries (which were stopped out for 15-20 points each) mean this one winner covers all the losses and then some.
Abandoning the strategy after a losing streak
Losing streaks of 5-7 trades are statistically normal with a 40% win rate. The edge is in the long-term math, not in any single trade. If your backtest shows positive expectancy over 100+ trades, trust the process.
Using trend following in a range-bound market
Check whether the market is trending before applying the strategy. If the moving averages are flat and tangled, there is no trend. Sit out until a clear direction emerges.
Setting fixed profit targets instead of trailing stops
Trend following makes money by catching large moves. A fixed target of 20 points would have exited the example trade far too early. Trail your stop and let winners run.