Trend following is a trading strategy, where investors seek price trends and invest according to them because they expect the trend in price movements to continue. The main goal of the trend following strategy is to beat simple long term strategies as buy and hold or cost averaging strategy. A trend can be defined in various time frames (weeks, days, hours, etc.) and has three primary forms: up-trend (bullish), down-trend (bearish) and sideways trend. Up-trend represents a market state where the price of a particular asset rises stable over a certain period. On the opposite, down-trend is represented by a continuous decline in prices. When prices do not significantly change over a certain period, we talk about the sideways trend.
The key for an investor is to buy an asset when its price trended up in the previous period, and sell when prices drop. His intention is not to forecast any future price level. He simply jumps on the trend and stays in the position until he considers the trend valid. It means that this strategy is only price-based and does not concentrate on any fundamental analysis of an asset. The determination of the trend is based on a technical analysis of the price chart by using various trend-following indicators.
The most simple and common indicator is the Moving average. Moving average compiles price data for each time point over a certain period chosen by investor and creates a single, fluent line. A trader decides, which moving average to use according to time frame, in which he trades—for example, long-term following investors use 50-day, 100-day and 200-day moving average. As the confirmation of a trend, traders often consider the crossing of moving averages. For example, the long term up-trend is confirmed, once the 100-day moving average crosses and goes above 200-day moving average. Some other popular trend indicators are, for instance, RSI (Relative strength index oscillator) or MACD (Moving average convergence divergence).