Trend following explained: the evidence behind long-run directional strategies

Trend following is the systematic approach of buying assets in uptrends and selling (or shorting) assets in downtrends, applied across markets and held until the trend reverses. It is one of the oldest documented investment strategies—commodity trading advisors (CTAs) have employed it for decades—and it has a robust empirical foundation extending back more than a century. Its defining characteristic is that it generates returns in environments where most traditional asset classes struggle, making it a genuine diversifier rather than merely a different way to own equities.

What trend following is

Trend following is the live-market implementation of time-series momentum: if an asset's price has been rising over the past months, the strategy goes long; if it has been falling, it goes short or exits. Unlike cross-sectional momentum, which ranks assets relative to each other, trend following takes an absolute signal from each asset's own price history. A trend follower might simultaneously be long equities (in an uptrend), long oil (in an uptrend), and short bonds (in a downtrend) regardless of how these assets rank against each other.

The strategy is typically applied across a diverse universe of futures markets: equity indices, government bonds, currencies, energy, metals, and agricultural commodities. The breadth of the universe is important: with exposure across twenty to sixty markets, the portfolio is diversified across trend opportunities in different geographies and asset classes simultaneously, reducing dependence on any single market's trending behaviour. This multi-market diversification is part of what gives trend following its distinctive return profile.

How it works

A standard trend-following implementation defines the trend using a moving average crossover or a breakout signal. In a simple moving average system, a position is entered when the short-term moving average (e.g., the fifty-day) crosses above the long-term moving average (e.g., the two-hundred-day), and is exited or reversed when the opposite crossover occurs. More sophisticated implementations use multiple lookback windows simultaneously—a position is sized based on the consensus of signals across several time horizons—which smooths the entry and exit behaviour and reduces sensitivity to a single lookback period's characteristics.

Position sizing in trend following is typically volatility-adjusted: each position is sized so that its expected daily price move contributes an equal risk contribution to the portfolio. This means larger positions in less volatile assets (government bonds) and smaller positions in more volatile ones (oil, equity index futures). Volatility scaling also reduces position sizes automatically when markets become more turbulent, creating a built-in risk management mechanism that reduces exposure when uncertainty is highest.

What the evidence shows

Hurst, Ooi, and Pedersen (2017) extended the documented evidence on trend following to cover 135 years of data across 67 markets in equities, bonds, currencies, and commodities. They found consistent positive returns from a time-series momentum strategy across this entire period, including both world wars, the Great Depression, multiple inflationary episodes, and the global financial crisis. The annual Sharpe ratio over the full period was approximately 0.4—similar to the equity premium—but with a pattern of returns that is largely uncorrelated with equity markets in normal conditions and positively correlated in crisis periods.

The "crisis alpha" property—trend following performing well during equity bear markets—has been observed in most major equity downturns of the past fifty years. During the 2008–2009 financial crisis, managed futures trend-following strategies returned approximately +18% on average while the S&P 500 fell −37%. During the dotcom bust of 2000–2002, trend followers with commodity and bond exposure did well as both commodities and bonds trended strongly while equities fell. The mechanism is straightforward: sustained, directional crises create trends in other markets (bonds rally, currencies move, commodities react) that a well-diversified trend-following portfolio captures.

Limitations and trade-offs

Trend following performs poorly in choppy, mean-reverting markets where prices oscillate around a stable level without establishing a clear direction. The strategy generates its worst returns when trend signals trigger positions but markets quickly reverse, producing a sequence of small losses from repeated whipsaws. Periods of range-bound equity markets—such as 2009–2010 and parts of 2023—tend to produce flat or slightly negative returns for trend followers.

The 2022 environment was an exception that illustrated both the strategy's strength and its unusual nature: trend followers had their best year in decades as inflation drove sustained trends in bonds (down), commodities (up), and currencies. However, 2022 also underscored that trend following's best environments are precisely when other strategies struggle—making it valuable as a portfolio diversifier but uncomfortable to hold during periods when it underperforms in an otherwise healthy market.

Trend following in pfolio

Time-series momentum—the academic formalisation of trend following—is documented in Moskowitz, Ooi, and Pedersen (2012) and is one of the core selection signals in pfolio's portfolio construction process. The platform applies trend signals across all tradeable asset classes in its universe at each monthly rebalancing to tilt allocations toward assets with positive price trends and away from those with negative trends. For a detailed explanation of the time-series momentum signal specifically, see time series momentum. Full methodology is available in how we build portfolios.

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