What Is Trend Following?
Trend following is a strategy that attempts to capture gains by analyzing the momentum of a particular asset. When a trend is identified, the trader enters in the direction of that trend and holds until the trend shows signs of reversing. The key principle is simple: the trend is your friend until it ends. In futures markets, trends can last days, weeks, or even months, providing significant profit opportunities for patient traders.
Why Trend Following Works in Futures
Futures markets trend because of institutional flow. Large institutions like pension funds, mutual funds, and hedge funds cannot simply buy or sell massive positions without moving the market. Their orders create persistent pressure in one direction over time. This institutional activity creates the trends that trend followers aim to capture. Additionally, futures markets have excellent liquidity and transparency, making it easier to identify and follow trends.
Key Indicators for Trend Identification
Several technical indicators help identify trends in futures markets. The Exponential Moving Average (EMA) is particularly useful because it gives more weight to recent price action. A common approach is to use the 20-period and 50-period EMAs. When the shorter EMA is above the longer EMA, it indicates an uptrend; when below, a downtrend.
The Volume Weighted Average Price (VWAP) serves as a dynamic trend indicator throughout the trading day. When price is above VWAP, it suggests bullish sentiment; when below, bearish sentiment. Institutional traders often use VWAP as a benchmark for their execution, making it a reliable trend reference.
The Average Directional Index (ADX) measures trend strength regardless of direction. ADX values above 25 suggest a strong trend, while values below 20 indicate a weak or ranging market. Combining ADX with other indicators helps filter out ranging markets where trend following tends to underperform.
Entry Strategies for Trend Following
One effective entry strategy is buying pullbacks to the EMA in an uptrend. When price pulls back to the 20 or 50 EMA and shows signs of bouncing, it provides a favorable risk-reward entry point. The key is to wait for confirmation—look for bullish candlestick patterns or a bounce off the moving average with increasing volume.
Another approach is breakout trading within a trend. When price breaks above a recent consolidation or resistance level in the direction of the trend, it often signals the continuation of that trend. Volume confirmation is crucial here—breakouts on higher volume are more reliable.
Exit Strategies for Trend Following
Trailing stops are essential for trend followers. As the trade moves in your favor, trail your stop loss behind price action. A common method is to trail below the most recent swing low in an uptrend. Moving average crossover systems can also signal exits—when the shorter EMA crosses below the longer EMA, it may indicate the trend is weakening.
The Importance of Patience
Trend following requires patience. Trends take time to develop, and there will be periods of consolidation along the way. The key is to stay with the trend as long as possible and avoid the temptation to take profits too early. Many traders exit winning trades prematurely, only to watch the trend continue without them. Trust your analysis and let your winners run.
Trend Following Checklist
- Identify the overall trend using multiple timeframes
- Confirm trend strength with ADX above 25
- Look for pullback entries to key moving averages (20 or 50 EMA)
- Use volume confirmation on breakout entries
- Set initial stop loss below the recent swing low
- Trail stops as the trade moves in your favor
- Take partial profits at predetermined levels
- Be patient and avoid premature exits
- Keep a trading journal to review your trend following performance
Practical Example
Consider a scenario where you're trading the E-mini S&P 500 futures (ES). The daily chart shows the 50-period EMA above the 200-period EMA, indicating an uptrend. On the 1-hour chart, price pulls back to the 20 EMA and forms a bullish engulfing pattern. You enter long with a stop below the pullback low. As price rises, you trail your stop below each new higher low. This approach allows you to capture a significant portion of the trend while managing risk.
Remember that no strategy works 100% of the time. Trend following will have losing trades during ranging markets. The key is to accept small losses during choppy periods and let your winning trades during trending periods more than compensate. Position sizing is crucial—never risk more than 1-2% of your account on a single trade, regardless of how confident you are in the trend.