Advantages of Trend Following
• Plenty of advantages of trend following – it is simple to understand (though not easy to implement).
• One may usually not miss a major move in any stock. If the market/stocks you are trading turns from a down to an up direction, any trend-following indicator must give a “buy” signal. It’s just a question of when. If it’s a major move, you will get the signal.
• Short term frequent trades will cost you more, because it will hurt on transaction costs. The farther longer term the trend-following indicators are, the lower the transaction costs are, which is a great advantage of trend following.
• Strategically, the investor must understand clearly that if he can get onto a stock on a major move in almost any stock, the profits from just one trade can be substantial.
• In essence, one single trade can make your whole year greatly profitable. Hence, the reliability of one’s strategy can be far below 50 percent and you’ll still obtain a profit. This is because the average size of one’s winning trades is so much greater than the size of one’s losing trades.
Disadvantages of Trend Following
• The major disadvantage is that trend following is not easy. You have to be alert for the entire time the markets are opened.
• It’s not easy to identify the entry and exit points
• Another disadvantage of trend following is that your entry and exit points cannot detect the difference between a major profitable move and a short-lived unprofitable move.
• Most markets spend a large amount of time in the territory where it is not usually possible to establish a trend – called the non-trending conditions. Trending periods could be very small – just 15 to 25 percent of the time. Yet the trend follower must be willing to trade in these unfavorable markets in order not to miss the big trend.
Who can go for trend following? Is it for Everyone?
Trend following is probably one of the easiest techniques for the new trader or investor to understand and use. The longer term the indicators, the less that total transaction costs will affect profits. Short-term models tend to have a tough time overcoming the costs of doing more trades.
| The fewer trades you make, provided you have the patience for it, the less you spend in transaction costs and the easier it is for you to make a profit. Apart from that, there is an inherent risk of the markets going against you. So analyze your situation completely, then and only then follow a trading strategy. | Table of Contents |
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