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Understanding How Trend Following Works as a Trading Strategy

Trend following trading is a strategy used in different types of markets, including forex, stocks, equity futures, bonds, crypto and commodities. The concept behind this type of trading revolves around identifying trends in the marketplace - either an uptrend or downtrend - and capitalizing on them to generate profits. This can be done through various methods such as technical analysis (looking at charts) or fundamental analysis (examining news).

At MacroVisor we use trend following as a part of our strategy for our macro + momentum swing trading ideas. This article will cover the basics of trend following to provide a foundation for understanding how it works.

In simple terms, trend following involves buying assets when they are going up and selling them once their prices start falling. However, this strategy also requires a trader to know how to read trends properly; it's not always easy to tell if an asset has reached its peak or is about to plummet in value based on just one piece of information.

There are three main types of market trend: uptrends, downtrends and consolidations. An uptrend occurs when prices move higher over time while a downtrend happens vice versa; both indicate the general direction that markets will follow next. Consolidation periods occur between trends where no clear direction is established yet but could break out into either an uptrend or downtrend at any moment.

Trend following capitalizes on these trends by identifying them early and riding them until they end. For example, if a trader notices that the price of gold has been steadily increasing for several weeks (an uptrend), he might decide to buy some gold futures contracts with the expectation that this trend will continue. On the other hand, if the same trader sees oil prices dropping consistently over time (a downtrend), he may choose to sell off his holdings in petroleum stocks or invest in inverse ETFs designed to profit from falling oil prices.

To identify these trends effectively, traders often use technical indicators such as moving averages and relative strength indexes which help them determine the direction of price movements based on historical data. Some other methods used include identifying breakouts or breakdowns (when an asset breaks above or below a certain level), reversals (a change in the current trend), continuations (where existing trends continue), volatility expansions (periods where market activity picks up) and more complex strategies involving multiple timeframes and indicators.

Managing risk is essential when engaging in any type of trading, including trend following. One common way to do this is by using stop loss orders - a predetermined point at which the trader will automatically sell their position if the market moves against them too far. There are two main types: hard stops (a fixed amount below or above your entry price) and trailing stops (which follow the market price and move in its direction).

Another important aspect of risk management is understanding asset volatility - how much an asset's value fluctuates over time - as this directly impacts how you should size positions. For example, highly volatile assets require smaller position sizes because they can move quickly against your favor while less volatile ones allow for larger bets without significant risks.

In closing, trend following trading is a strategy that involves identifying and capitalizing on trends in various markets to generate profits. These trends are identified using technical indicators and other methods such as breakouts, reversals, continuations, volatility expansions etc., while risk management plays an important role through stop loss orders and position sizing based on asset volatility.

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