The Advantages and Disadvantages of "Trend Following"

The Advantages and Disadvantages of "Trend Following"

Advantages:

The benefit of trend following is simple. You will never miss a major move of any market. If the market you are watching turns from a down to an up direction, any trend-following indicator must flash a "buy" signal. It's just a question of when. If it's a major move, you will get the signal. The longer term the trend-following indicators are, the lower the transaction costs'a specific advantage of trend following. Strategically, the investor must realize that if he or she can get on board a major move in almost any market, the profits from just one trade can be considerable. In fact, one trade can make your whole year. Thus, the reliability of one's strategy can be far below 50 percent and you'll still show a profit. This is because the average size of the trader's winning trades is so much greater than the size of his losing trades.

Disadvantages:

The drawback of trend following is that your indicator cannot detect the difference between a major money-making move and a short-lived unprofitable move. As a result, trend followers often get whipsawed as trend-following signals immediately turn against them, causing small losses to occur. Multiple whipsaws can add up, creating concern for the trend follower and tempting him or her to abandon the strategy. Most markets spend a large amount of time in non trending conditions. Trending periods could be as little as 15 to 25 percent of the time. Yet the trend follower must be willing to trade in these unfavorable markets in order not to miss the big trend.

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About the author: Stock Advisor Group Editorial Team