Trend Following Strategies: A Practical Guide

Abstract

Trend-following strategies, rooted in time-series momentum, have demonstrated enduring efficacy across diverse asset classes and market conditions. This paper provides a comprehensive exploration of the theoretical foundations, risk-return dynamics, and practical implementation of such strategies. Key findings reveal that trend following strategies exhibit convex return profiles with ''crisis alpha'' properties, thriving during market dislocations while offering diversification benefits. The choice of time scale for trend calculation is paramount, as strategies must align with an asset’s return characteristics. Empirical simulations and comparative analyses of trend measures underscore that methodology matters less than selecting an appropriate time horizon.

Empirical evidence from China’s futures markets (1999–2019) confirms the global applicability of trend following, with a combined multi-scale strategy achieving a 16.24% annualized return and a Sharpe ratio of 0.88, significantly outperforming buy-and-hold approaches. However, challenges persist, including periods of underperformance linked to heightened asset correlations, reduced market trends, and leverage sensitivity. Critically, the strategy’s success hinges on disciplined risk management and acceptance of short-term drawdowns. By synthesizing academic insights and practical considerations, this study reaffirms trend following as a resilient, albeit imperfect, tool for portfolio diversification and crisis hedging, urging practitioners to prioritize time-scale alignment and robust risk controls.