Markets are in two states, trending, and ranging. Trending, in its most basic terms, is when the markets are moving either up or down in a sustained manner and ranging is when the market is moving sideways staying within a small range of price. One of the hallmarks of a trending market is to see a steady set of new highs and higher lows or lower lows and lower highs.
Trend following is based on the theory that markets sometimes move for long enough in a given direction that one can identify this trend and ride it. The economic rationale for the existence of such trends is based on the idea of consensus building among the different market participants.
The oldest trend following strategy was created by Richard Donchian who some call the father of trend trading. Originally he started his career with stock trading but in 1948 he created a new company called Future Inc. which was the first publicly held commodity fund. His main thesis was about commodity trend timing, where he observed that many markets either follow a Bull or Bear stance and he decided to build a system to detect when the trends began and then ride them. The basic premise of his strategy was simple
If a given market’s price is above the highest closing price over the past 2 weeks, buy the market. If its price goes below the lowest closing price over the past 2 weeks, sell it short. In between those times hold on to whatever was in your portfolio.
Sounds very simple, but using this system, from 1950 to 1970 he built an extremely successful track record and now manages billions of dollars. What this means for you as the trader, you do not always need highly complex mathematical equations and a supercomputer to crunch numbers but a simple well-tested system.
Most trend trading requires you to use lagging indicators such as moving averages to help judge when a trend is in place and when it is ending. You will find that the moving average will flatten out when you are moving to the end of a trend.
Markets trend around 35% of the time, so you will want to know how and when to enter the market.