A Discretionary Approach to Trend Following Trading
I have previously written about trend following trading and shared a systematic trend following strategy you can try. This time, I wanted to go over a discretionary strategy based on those same sound principles that make up the concept of trend following trading.
Trend following itself is a solid approach to trading on many timeframes, and it is one of very few simple trading strategies that can be applied profitably over longer time periods. The validity of trend following has even been confirmed by research from large banks like in this CitiBank report from 2015.
As evidence of the popularity of this trading style, the report states that trend following strategies are “without a doubt the most popular systematic rule-based strategies used…” Further, it estimates that at least 85% of returns by so-called Commodity Trading Advisors (CTAs) can be explained by simple trend following strategies.
Discretionary vs. Systematic Trading
As you may already know, traders and trading strategies can be divided into two groups; discretionary and systematic traders. You should also make a choice as to which category you feel you belong in. Some people like to have fixed rules that they can follow in the same way every time (systematic traders), while others believe they have an ability to “read” market conditions and get a feel for what works and what doesn’t (discretionary traders).
There is no right or wrong as to which one is better. However, it is a fact that many of the big and well-known trend followers and CTA’s stick to their systems and rarely make any adjustments to them.
Let’s take a look at the strategy.
The technical indicators you need for this strategy are:
- 20 and 200 Moving Average
- Average True Range (ATR)
- The “Average True Range Trailing Stops” indicator in TradingView is a good choice (set to 14, 2)
If the 200 Moving Average is pointing up and the price is above it, we have an uptrend.
When it is determined that we have an uptrend, wait for the price to test support at the 20 Moving Average line.
If price hits this line and then bounces off twice, enter your buy order the third time it hits.
Set a trailing stop-loss 2 ATR from your entry. Unless you have access to more advanced trading software, you will have to adjust this stop level as the ATR moves upward. It’s not that much work though, especially not if you are trading on higher timeframes like the 4H or 1D.
Profit target: None. This may be shocking to some, but the approach taken by most trend followers is to hold on to the trade until the trailing stop is triggered. After all, why would you want to limit your profit potential when your goal is to ride the trend for as long as possible?
Lastly, in terms of risk management, I like to size my position so that I risk only 1% of my trading account on each trade. 2% is another common number to use. However, trend following strategies typically has lower win rates but with higher reward:risk ratios, so I like to leave some room for error.
The reason why I call this trading strategy discretionary is because it doesn’t have any hard rules. You can modify and adjust it as you want, for example by waiting for some kind of confirmation before you enter your order. You may also try to add for example the 50 MA and use as a trailing stop instead of the ATR line. And you can play around with the ATR settings to find an optimal setting for the market you are trading.
Which markets to trade?
The most important factor here is that you have to look for markets that are clearly trending. This is where your ability to “read” markets really comes to use. Check if the market has had a tendency to trend in the past. Although the 200 Moving Average is sloping up, it could still be a choppy market without clear direction.
As mentioned at the top of the article, the biggest players among trend followers are the CTAs typically trading commodity futures and currencies. However, it can also work well on stocks and probably cryptocurrencies as well.
Bring up your charts and do some visual backtesting so you can get a feel for how it performs in the market you are trading before dipping your toe in the water.
Featured image from Pixabay.