What is Trend Following? A Painful Journey to Smarter Investing

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When it comes to choosing an investment strategy, most investors—whether they realize it or not—are looking for something that:

1. Beats the benchmark
2. Never loses money
3. Works all the time

And here’s the harsh reality: this unicorn of a strategy doesn’t exist. Anyone promising you all three is either blissfully ignorant or straight-up lying.

Trend following is no exception.

Trend following is one of the most psychologically grueling strategies an investor can undertake. Why? Because it frequently strays—sometimes dramatically—from the benchmark. When it excels, it feels exhilarating. When it lags, it’s agonizing. And that agony isn’t fleeting—it can persist for long stretches, testing even the most patient investors.

That said, multi-asset trend following can be a powerful tool for preserving capital during major market drawdowns, making it an excellent complement to a traditional long-only portfolio. But is it worth the pain? 

Let’s dig in.

What is Trend Following, and Does It Work?

Trend following, at its core, is a strategy where investors buy an asset when it’s going up and sell when it’s going down. But unlike panic-driven investors who sell at the worst possible moment, trend followers adhere to a rules-based approach in an attempt to remove emotion from the equation. This approach can be applied to multiple asset classes, including equities, bonds, commodities, and currencies.

But does this strategy “work”?

In his paper Absolute Momentum: A Simple Rule-Based Strategy and Universal Trend-Following Overlay, Gary Antonacci ran a simple trend-following strategy on multiple asset classes from 1974 to 2012. The results were compelling: trend-following consistently showed higher Sharpe ratios, shallower drawdowns, and, in most cases, better performance than buy-and-hold.

Other studies have found similar results. Trend following has historically delivered returns comparable to buy-and-hold while offering better risk-adjusted performance.

Measuring Trend: Finding the Signal in a Sea of Noise

So how does one go about measuring trends? No, you can’t just squint at the screen and see if “line go up.” Trend followers must measure buy and sell signals in a systematic and mathematical fashion, manage their risk, and execute trades decisively.

Here is a short (and definitely not exhaustive) list of tools that may be used by managers to determine what’s a buy or sell:

Time-series rule: Evaluate an asset’s total performance over “x” days or months and compare it to the return of cash over that same period. If the asset beats cash, buy. If cash beats the asset, sell. In general, managers prefer longer lookback periods ranging from 3 to 12 months.

Moving average rule: Average the total daily performance of an asset over the past “x” days and compare it to the price of the asset today. If the asset price is above the moving average, buy. Otherwise, get out of the way.

Dual moving average rule: Compare a short-term moving average (say a 30-day moving average) to a long-term moving average (say a 200-day moving average). If the short-term moving average is above the long-term moving average, invest. If not, sell.

Regression based rule: Regress past price data over “x” number of days. If the beta is positive, you’re in an uptrend. If beta is negative, you’re in a downtrend.

Trend breakout rule: Identify support and resistance levels. If the asset price breaks above resistance, go long; if it breaks below resistance, go short (or move to cash).

After determining which rules they will use, trend followers select their assets, weight them (usually based on risk budgets), establish a rebalance cadence, and blindly follow their system (hopefully).

The Psychological Toll of Multi-Asset Trend Following

On paper, trend following looks like a dream. Who wouldn’t want a strategy that can potentially deliver buy-and-hold-like returns while avoiding catastrophic losses? But in practice, it’s excruciating.

Imagine watching the asset surge while you sit in cash, or even worse, are short. Ouch! That psychological strain is why so many investors abandon trend following at the worst possible time.

When you zoom out, multi-asset trend following looks fantastic. But zoom in, and you’ll see long stretches of underperformance. To stick with it, you need to fully understand what trend following is—and what it isn’t.

Trend is Positional, Not Predictive

Here’s where many investors get it wrong: trend following isn’t about predicting market movements. It’s about positioning yourself for potential market crashes across multiple asset classes.

Think of it like hurricane preparedness. If you live in Florida, you know the drill: put up shutters, buy a generator, and stock up on supplies. Most of the time, the hurricane misses, weakens, or fizzles out. But sometimes, it hits—and when it does, you’ll be grateful you were prepared.

Trend following is the financial equivalent of boarding up your windows. Usually, you’ll take small, annoying losses from false alarms. But when a real market storm comes, you have a chance of being protected while everyone else is scrambling for cover.

The Payoff: Small Losses, Huge Wins

Multi-asset trend following therefore thrives on small, frequent losses followed by rare but massive wins. This makes it a perfect counterbalance to traditional investing. 

Put simply: traditional portfolios take the escalator up and the elevator down. Trend overlays take the escalator down and the elevator up.

One of the simplest ways to use trend following is by applying it across highly diversifying asset classes and bolting the strategy to a buy-and-hold stock portfolio. This approach minimizes the tracking error that comes with a pure trend-following portfolio while still offering defense against major market downturns.

If you can eat tracking error for breakfast, lunch and dinner, maybe trend is an overlay you want to implement across your entire portfolio. This approach is robust on paper, but extremely hard to stick to in practice.

Keys to Sticking with Multi-Asset Trend Following

If you’re considering trend following, keep these points in mind:

1. Whipsaws are part of the process.
   You will get kicked out of trades only to buy back in at higher prices. It’s frustrating, but it’s part of the game. Don’t abandon the strategy just because of short-term noise.
   
2. Expect to be wrong—A LOT.
   Trend following isn’t about being right all the time. You will be wrong often, sometimes for years. The key is surviving long enough for the big wins to materialize.
   
3. Welcome to the club!
   Trend is often ignored, dismissed, or outright ridiculed by traditional investors. But a dedicated group of investors—including myself—swear by it. If you decide to join us, buckle up for a bumpy but hopefully rewarding ride.