Trend Following Strategies
Trend following strategies are those which try to exploit the persistent directional movement in prices. They differ from the momentum strategies in entry criteria such that entry is nor based on price over-reaction patterns.
Common Indicators used for trend following strategies
Single Moving Average:
Moving averages are perhaps the most common technical indicators used to define a trend following strategy. The crossover of a moving average with the prices itself is considered signals for Buy/Sell.
Two Moving Averages:
The crossover between a fast and alow moving average is considered a signal for Buy/Sell
Three Moving Averages:
The crossovers between a mid-term moving and short-term moving average are used for generating Buy/Sell signals. A long-term moving average is used for finding the direction of trend. The Long/Short entries are taken in confluence with the long-term moving average.
Average Directional Index
ADX is perhaps the most commonly used indicator for trend following. The general rules are:
- If ADX crosses above 25, the market is trending.
- If ADX crosses below 20, the market is consolidating.
- If ADX crosses below 45 after being higher, the market is consolidating.
- If ADX rises above 10 on 3 of 4 days after being lower, the market will start to trend.
- A trend based on rule 4 remains in effect until the 5-day difference in the ADX is less than 0.
SuperTrend indicator is calculated by offsetting Average True Range (ATR) to create upper and lower band around prices. The direction of trend is decided by further using a stop-and-reverse trailing stop loss and then resetting the upper/lower bands when the TSL is breached.
Bollinger Bands, ATR Bands, MA Bands
Bands can be used to generate buy signal when price moves above upper band; and sell signal when price moves below lower band. Such signals will be considered trend following because prices cross the band whenever there is persistent directional movement.
Random Walk Index
The crossovers between RWI of Highs and RWI of Lows can be used to define a trend following strategy
A n-period range breakout strategy also comes under trend following.
Relative Strength Index
RSI indicates upward/downward drift in the market.
Buy: If RSI remains above 30 level for the last 20 periods, AND RSI crosses above 70 level
Sell: If RSI remains below 70 level for the last 20 periods, AND RSI crosses below 30 level