This post is written by Jet Toyco, a trader and trading coach
It’s probably the first strategy you learned as a trader – the classic art of riding the market waves.
Just enter with a trailing stop loss, and call it a day, right?
But guess what?
There’s more to it than meets the eye!
Did you know that trends come in different flavors?
There are smooth and easy trends while there are “bull trap” parabolic trends!
Just like ice cream, they have their unique twists and turns.
And with these different types of trends…
There are also exciting variations when it comes to trend following strategies.
So, my fellow traders.
Fasten your seatbelts as we embark on a journey to unravel the secrets of trend following!
Here’s what you can expect in today’s complete guide:
- The captivating world of trend following strategies and how they ride market waves.
- Common trend following indicators: Donchian channel, Chandelier Stop, moving average, and price action.
- The two types of strategies: discretionary (intuition-based) and systematic (rule-based).
- Secrets of a good trend following strategy: timeframe selection, market screening, risk management, and trade execution skills. Get ready to elevate your trading prowess!
- A complete price action strategy for thriving in the crypto markets
- A back-tested and proven systematic strategy that works in almost all markets
You damn should be!
As I’m spilling all my trend following trading secrets in this guide.
So, let’s get started!
Unraveling the Trendy Magic: How Trend Following Strategies Rock the Trading World
Alright, my friend…
Let’s dive into the groovy world of trend following strategies!
So, here’s the deal:
While other traders might be chasing the elusive “top” of the market like it’s the last slice of pizza…
Trend following strategies take a different approach.
These strategies are all about capturing the entire move, my friends.
Yep, you heard it right – it’s like catching a wave and riding it to the shore!
With trend following, you may miss out on being the first to shout “I caught the tippy-top!”
But fear not, because you’re in for the whole wild ride.
It’s not a “ride” a lot of traders can stomach.
So, let’s paint a picture to make it crystal clear what you might be getting into…
Imagine you’re at a roller coaster park, and the market is the coaster.
Trend following is like hopping on that coaster and embracing the full thrill.
You don’t get off mid-ride, oh no!
You stay put, enjoying (or screaming) every twist, turn, and loop-de-loop.
Similarly, trend following strategies keep you strapped into the market action from start to finish.
You may not always predict the highest peak, but you’re there to catch the entire heart-pounding, adrenaline-pumping adventure.
That makes sense, right?
Adopting trend following strategies isn’t exactly easy breezy as other traders aught it to be.
But it’s a trading methodology where it’s 20% execution, and 80% psychology (a.k.a. staying on the roller coaster ride)
So, buckle up my friend.
Because the next section will show you the key indicators and tools that are suited for making trend following strategies.
So that after you finish this training…
You’ll have the power to create your trend following strategy.
Then keep reading.
Unveiling the Trendy Tools: Rocking Indicators for Trend Following Strategies
Indicators, my friends, are the secret sauce of trend following strategies.
This is why I’ll unveil some of the coolest tools for you in today’s guide!
And what are those tools you may ask?
We’ve got the:
- Donchian Channel
- Chandelier Stop
- Moving Average
- Price Action
Now let me explain in further detail as these babies are about to become your new best friends on your trading journey.
So, let’s kick it off with the Donchian channel.
This little gem is like having a visual representation of the market’s highs and lows right on your chart.
No errors, and no guessing games.
If you want to determine the highest highs and the lowest lows for the past 50 days?
Just place it into the settings then boom.
Again, no errors.
A very straightforward indicator, am I right?
So, what is this indicator best used for?
Well, it’s the ultimate timing tool for your entries and exits.
Imagine having the clarity to jump in when the time is right and hop off the train just before it takes a nosedive.
That’s the Donchian channel magic, my friends.
An all-in-one simplistic indicator!
But of course, that’s not all!
Next on the scene, we have the Chandelier Stop.
Sounds fancy, right?
Well, it’s more than just a stylish name.
Because it’s the Average True Range indicator (which you’re probably not sure how to use):
But with a fabulous visual twist.
Boom, now you know how to use the ATR all of a sudden!
Makes a whole lot easier, right?
Instead of manually subtracting the ATR to determine your stop loss, you already have it on your chart served for you!
Now, this bad boy helps you set both your initial and trailing stop loss like a boss.
If you go long, you can place your stop loss at the green line.
If you go short, you can place your stop loss at the red line!
It’s like having a trusty bodyguard by your side, protecting your hard-earned profits while still giving the market room to dance!
Ah, and who can forget the popular moving average?
It’s like the trend-following maestro, constantly measuring the average movement of the price.
Picture it as your guide, leading you through the wild market terrain.
However, one thing it’s truly good for is:
1. Objectively defining a long-term trend
2. Timing entries on a pullback
3. Trailing your stop loss.
It’s no wonder why the moving average remains to be one of the most popular indicators out there.
Because on the right trader’s hands…
This indicator can be flexible enough to capture all types of trends.
That’s why don’t you dare underestimate this indicator!
So, my trading amigos…
Embrace these indicator heroes, learn their quirks, and make them a part of your trend-following arsenal.
Because in the later section, I’ll share with you which ones to use (and how to use them).
But before we get into the strategies themselves…
There’s one thing most traders miss out on.
And that is being able to distinguish discretionary and systematic trend following strategies.
Let me tell you more in the next section…
Decoding the Dance: Discretionary vs. Systematic Trend Following Strategies
In the mesmerizing world of trend following…
Two distinct partners take the stage: discretionary and systematic trading.
These two have their unique styles, moves, and philosophies.
So, what makes them different?
Discretionary trend following strategies
First up, we have the improvisational maestro: discretionary trend following.
It’s like freestyle dancing on the charts, where you make the calls based on your judgment and intuition.
With discretionary trading, you have the freedom to adapt to any market condition.
Twirling and spinning with the ever-changing trends.
The best part?
Being discretionary gives you a chance to showcase your creativity and seize explosive gains when the stars align.
And that is what makes discretionary trading appealing!
But let’s be honest…
This dance isn’t always a walk in the park.
The downside of discretionary trend following strategies (and how to fix it)
With the word “discretion” in itself…
Subjectivity can creep in, leading to analysis paralysis and second-guessing.
There’s also a chance that you’ll start mixing and matching indicators just to recover from your loss!
Furthermore, it takes a bit of “faith” to see whether or not your process and strategy work!
So, what’s the remedy to this?
- Having a trading plan
- Having a trading journal
Those two things are the key to having a working and sustainable discretionary trend following strategies.
Sure, things will still take time before you can see those greens on your portfolio!
So, if you’re into discretionary trading, then these guides will help you out…
Now, let’s switch gears and meet the disciplined partner…
Systematic trend following strategies
Systematic trading is like executing a well-rehearsed performance, where every move is pre-defined.
No room for interpretation here!
Price breaks above the 50-day high?
Breaks below the lows?
It’s all about simplicity and objectivity, allowing you to focus on executing the steps flawlessly.
So, for example…
If you have a valid entry signal but then you hear news like:
“The markets are crashing”
“War is about to start!”
“Banks are crashing!”
What do you do as a systematic trend follower?
You enter the trade with no hesitation.
That’s what it means to adopt systematic trend following strategies!
Another upside of systematic trading is that you can easily test your strategy since rules are often simple and can be coded to backtest years of data repeatedly with ease.
In this case…
You’ll immediately know whether or not your trend following strategies has an edge in the market or not before you even put your hard-earned money!
So, by sticking to the rules…
You can filter out the noise and let your execution shine.
The downside of systematic trend following strategies (and how to fix it)
However, flexibility is not part of this dance.
The rules are fixed.
And losing years may be a part of the journey.
So, having the right mindset, expectations, and restraint to keep on tweaking your rules after a few losing trades is also the key to being successful.
Testing a system requires meticulous work, and you can expect 99% of the strategies you’ll test may not be profitable.
And even if you’ve arrived at that 1%, you’d have to make sure it’s robust enough that it’ll not only work in the past but also the future!
Again, what’s the remedy for this?
Good news for you, my friend!
As we have the book prepared for you if you wish to embark on the journey of being a systematic trend follower.
The best part?
You can check it out here: The Essential Guide to Systems Trading
So, there you have it!
The fascinating duo of discretionary and systematic trend following.
Each brings their flair to the dance floor, offering traders different paths to success.
So, it’s about finding the best one for you.
At this point, you might be wondering…
“Damn, I’ve learned a lot!”
“But when can you teach us a trend following strategy this time?”
“Show me the strategy right now!”
Don’t fret, my friend!
Because at the end of this section, I will provide you with two trend following strategies!
But before that, we must be clear on one thing, and this is important:
What makes a complete and tradeable trend following strategies?
Should you trade the crypto markets?
What indicators to use?
See what I mean?
That’s why in this section let’s dive into what makes a sustainable trading plan for trend following strategies!
The Trendy Secrets: Unveiling the Elements of a Killer Trend Following Strategy
Alright, my trend-following aficionados.
It’s time to spill the beans on what makes a good trend following strategy.
So, first off, we have the mighty number one…
#1: knowing your timeframe
Jumping from one timeframe to another all the time breeds inconsistency.
You’ve read that right!
Because if you’re entering trades off different timeframes inconsistently, how can you expect consistent results?
Hopping from one timeframe to another three timeframes makes it almost impossible to track whether your strategy works!
This is why for discretionary traders, I suggest you stick to one or two timeframes.
While for systematic traders, I suggest you stick to only one timeframe to make testing your system efficient.
Now, let’s move on to the marvelous number two…
#2: having a market selection process
Think of it as having your very own team of screeners that help you find the juiciest opportunities.
You’re not just randomly picking any ol’ stock or asset.
Oh no! You’ve got your criteria set, and you meticulously filter through the market to uncover those gems that align with your trend-following mojo.
That’s why no matter what markets you trade.
Having some sort of screener or a method to build your watchlist consistently is a must!
Next up, we have the powerful number three…
#3: knowing to manage your risk and portfolio
You’re not a reckless cowboy, my friend.
You know how to protect your capital and balance your portfolio like a seasoned tightrope walker.
So, when it comes to risk management you must answer these questions all the time:
- How much am I risking per trade? (e.g. 1% risk per trade)
- For stocks, how much should I allocate per trade? (e.g. 10% portfolio allocation)
- What are my maximum open trades?
- Do I have an exit method or stop loss in place?
Sure, it’s a checklist you can write down on your notepad.
But if you want to learn everything there is to know about risk management, you can check this out:
Last but not least, we have the game-changing number four…
#4: knowing your setup, trade management, and exits.
You’re not just shooting in the dark and hoping for the best.
No, no, no my friend!
You’ve got your setups dialed in (pullback, or breakout?).
Your trade management techniques fine-tuned (trailing stop, or fixed take profits?)
And your initial stop loss is planned like a grand finale before you even hit that buy button!
Because here’s the thing:
A lot of traders love gathering tips and pieces of advice just to enter a trade.
But when it comes to exiting the trade at a loss or profit?
No damn idea!
And that my friend, is not sustainable.
So, my fellow trend followers…
Remember these essential elements:
- Embracing your timeframe
- Honing your market selection process
- Mastering risk management and portfolio management
- Knowing your setup, trade management, and exits.
With these secrets in your pocket, you’ll be unstoppable in your trend following strategies which I will share with you in the next section.
Yep, you heard that right!
So keep on reading!
Trend following strategies for discretionary traders
Discretionary trading can be subjective at times, so there could be many different forms of trend following strategies!
But for this guide…
I’ll share with you a short-term trend following strategy for the crypto markets.
However, I first need you to take the consistently profitable trader’s oath.
I, (say your name)
Solemnly swear that I will backtest all of the strategies shared with me today first and make necessary tweaks to this strategy before risking my hard-earned money.
So that I can take full responsibility for my trading destiny.
So, here are our criteria for this trend following strategy…
- Market: Cryptocurrency
- Timeframe/s: Daily timeframe only
- Risk management: Maximum of 2% capital loss per trade if the price hits stop loss
- Market selection: Focus on the top 20 most capitalized crypto coin
- Setup: Flag pattern breakout
- Initial stop loss method: Subtract 1 ATR below the lows of the Flag pattern
- Take profit method: 20-period moving average trailing stop loss
- Maximum open trades: 10
Now that you have those criteria…
How the hell do you execute this trend following strategy step-by-step?
Step #1: Market selection
All of this information on finding the top 20 capitalized crypto coins can be found in coinmarketcap:
After you’ve seen the list, all you have to do is to place it on your watchlist on your platform!
Step #2: Market setup
If you look at the criteria above, you should know that we are looking for a flag pattern breakout on the daily timeframe!
[BULL FLAG GIF]
This means that all you have to do is to look at the watchlist you’ve built and find which markets are building a flag pattern.
Following so far?
Step #3: Entries and exits
If we’re talking pin-point execution here, one thing I suggest is to wait for a bullish close from the flag pattern:
Then enter at the next candle open:
For your stop loss, you can subtract 1 ATR from the lows of that flag pattern!
Or if you prefer, you can use the chandlier stop (remember this indicator?):
Finally, trade management.
How will you manage this trade?
Again, looking at the criteria…
We’ll wait for the price to close below the 20-period moving average until we exit this trade:
There you go!
A complete discretionary trend following strategy!
But here’s the thing…
This strategy can be improved upon by:
- Adding more criteria to your market selection
- Adopting more trading setups
- Lowering your risk per trade and increasing your max open trades to diversify
But of course, I’ll leave it up to you!
Finally, we have the systematic trend following strategy…
Trend following strategies for systematic traders
Unlike discretionary trading…
We’ll perform a comprehensive backtest of the criteria before I share with you how to execute it!
This means that right from the start, you’ll know that the strategy has an edge and know what returns to expect.
So, here are the criteria for this strategy:
- Market: Forex, bonds, agriculture, commodities, and indices
- Timeframe/s: Daily timeframe only
- Risk management: Maximum of 1% capital loss per trade if the price hits stop loss
- Market selection: Focus on the 25 markets on the watchlist (fixed)
- Setup: 200-day breakouts
- Initial stop loss method: Subtract 6 ATR below the lows of the Flag pattern
- Take profit method: 6 ATR trailing stop loss
- Maximum open trades: 25
In this case…
We’ll test the system from the year 2000 up to 2022 via Amibroker with Norgate data.
So, how does the system perform?
First, are the basic statistics:
- Number of trades: 763
- Winning rate: 46.13%
- Annual return: 10.76%
- Max drawdown: -15.86%
- Risk-adjusted return: 85.19%
What does this all mean?
Does it mean you get to make 10.76% a year, guaranteed?
That’s not the case, my friend!
It means that there will be years where you’ll have BIG gains just like in the 2008 financial crisis and the 2020 pandemic:
And years where you’ll barely have any gains or just be at breakeven such as from 2015 to 2019:
Now, how about the maximum drawdown?
What does it mean?
Does it mean that you’ll lose a maximum of -15.86% every year?
It means that at one point in time…
The system has lost -15.86%
And finally, the equity curve:
Why is this important?
Well, traders look at the equity curve to see whether or not the system is worth risking your hard-earned money into!
And with everything you’ve seen so far in this test…
Would you trade this system?
It’s up to you, my friend!
It’s the best system around that makes 1000% every damn year.
But it sure does look like it has an edge in the market, having survived multiple financial crises!
Now, knowing how this system has an edge in the market, how do you exactly implement it?
Let me show you…
Step #1: Watchlist building
If you recall…
We’re trading different market sectors here such as forex, bonds, agriculture, commodities, and indices
But which markets are they?
Well, here are the markets I’ve included in the test:
I know what you’re thinking:
“What, these markets are correlated!”
“I should not be trading this system at all!”
And yes, you have a point!
However, correlation is not static and changes in the long run.
And when you apply the same principle across different markets where correlation is not static…
You get a nicely diversified portfolio that makes gains and losses more stable!
Also, you might be thinking:
“25 open max open trades?”
“Won’t I lose all money when I have those many open trades?”
I get you!
But if you look at the risk-adjusted return, where we divide the annual return and exposure from the criteria, you get an 85.19%!
This means that the strategy would perform better the more trades you have open!
So, now that you have those markets on your watchlist…
Step #2: Finding the setup
This trend following strategy is simple:
Wait for a 200-day high or low breakout close using the Donchian channel!
And set your initial stop loss at the 6 ATR chandelier stop!
Remember the indicators I shared with you a while ago?
Good, because all you have to do is to look for this same setup every trading day from your watchlist:
Finally, the most important part…
Step #3: Trade execution
Executing this system is simple as all you need are two indicators:
- 200-period Donchian Channel
- 6 ATR chandelier stop
So, if the price makes a new 200-day high:
You set your initial stop loss at the chandelier stop and enter at the next candle open via market order:
And only exit your trade if the price makes a close above the 6 ATR:
No drawings on your chart.
How can you improve this trend following a strategy system?
Since this system is robust, there are a couple of things you can tweak and the system would still have an edge in the market, and they are:
- Adding more markets to the watchlist
- Increasing or lowering the 200-day entry settings
- Increasing or lowering the 6 ATR initial and trailing stop loss
Mind’s all packed with knowledge?
Great, then let’s do a quick recap on what you’ve learned today!
Adopting trend following strategies has different forms with different tools you can use.
In the end, it’s all about finding the right style and tools for you and piecing them together in a way that won’t conflict with each other!
So, here’s what you’ve learned today:
- Trend following aims to capture the entire market move, embracing the thrill of riding market waves from start to finish.
- Common trend following indicators include the Donchian channel, Chandelier Stop, moving average, and price action, helping traders navigate market trends.
- Discretionary trend following allows traders to use judgment for decisions, while systematic trend following follows fixed rules and objective criteria.
- A good trend following strategy involves knowing your timeframe, employing a market selection process with screeners, mastering risk management, and being skilled in setups, trade management, and exits.
- A discretionary price action strategy for the crypto markets
- A systematic backtested strategy designed to trade different market sectors
There you go!
With that said, here’s what I want to know…
Have you tried any trend following strategies in the past?
How did it go?
And will you make some tweaks and try again after this guide?
Let me know what you think in the comments below!