What Is Trend Following?
What would it look like to turn 'ride while it rises, step off when it turns' from gut feeling into a rule? Trend following sets that rule with the moving average.
What Is Trend Following?
Trend Following is an investment method that follows the direction of price (the trend) by rules. A representative tool is the moving average.
For example, it is a simple rule: 'hold while the price is above the 200-day moving average, and sell and step back into cash when it drops below.' It is a rule-based attempt at risk management, aiming to ride up when it rises and step aside when it falls.
If the momentum seen earlier is more about 'comparing the rankings of many assets,' trend following is closer to looking at 'where a single asset stands relative to its own trend, above or below' (time-series momentum).
Meb Faber and Managed Futures
In his 2007 paper 'A Quantitative Approach to Tactical Asset Allocation,' Meb Faber presented a simple rule of trend-following 5 asset classes using a 10-month (about 200-day) moving average.
In the original paper's backtest (1972–2005), it returned about 11.7% per year with a maximum drawdown of about −9.5%, greatly reducing drawdowns compared to stocks over the same period. However, in the subsequent window (2006–2025), performance declined to about 6% per year with a maximum drawdown of about −11.7%.
What runs a similar principle at large scale is the managed futures (CTA) fund. These follow trends across stock, bond, currency, and commodity futures, and because they can respond to downtrends by short selling, they have also become known as 'crisis alpha' that actually earned returns in downturns like 2008 and 2022.
The figures approximate Faber's original paper and subsequent verification data, and vary with the assets, period, and cost treatment used. Past performance does not guarantee the future, and performance can decline, as in the recent window.
Strengths and Limitations
Strength: it attempts to exit early in a big downtrend to avoid the worst drawdowns. Being rule-based, it is easy to exclude emotions like fear and greed.
The limitations are also clear.
① Whipsaws in a sideways market: in a directionless market that rises and falls, you repeat 'buy and sell,' accumulating small losses and trading costs.
② Lateness: because a moving average is an average of past prices, it responds late. You sell a little late near the top and buy back a little late at the bottom.
③ Costs and taxes: frequent trading increases fees and taxes, and in a sharp V-shaped recovery, you can lag the market significantly.
よくある質問
Q. Does trend following always let me avoid big declines?
No. You can avoid a gradually rolling-over decline by exiting early, but in a case that plunges overnight, you take losses before the moving average can react. Also, if it rebounds sharply from the bottom, you may miss the recovery by buying back late. It is 'an attempt to reduce drawdowns,' not a 'guarantee of no losses.'
Q. Why do losses occur in a sideways market?
In a directionless market that rises and falls, you cross above and below the moving average frequently. Each time you buy and sell by the rule, you repeatedly buy a bit expensive and sell a bit cheap, producing small losses. This is called a whipsaw, and combined with trading costs, it eats into performance.
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