Definitive Trend Following Guide – Long

Turtle trading

A definitive trend following guide for a simple, reliable method to do equity based trend following. Check it out.

A few questions first.

Guide is just below here.

Does Trend following work?

Yes. Trend following, properly implemented, has a very solid R/R and yields impressive results. This shows a detailed, but simple system.

Trend following is directional and some of the strategies present very high risk, but some present much lower risk. Directional trades offer much higher returns, but also significantly higher risk. Most new traders use them extensively, but more seasoned traders hedge or spread the majority of trades, using fully directional trading for a minority of trades.

Best Trend Following Indicators

KISS applies. Simple is better. The 18 / 50 / 100 and 200 day moving averages make a clearly readable ‘fan’ like in this chart. The fan has the longest average at bottom and shortest at top. Reverse for downtrend.

Trend Following SPY chart.
MSFT in clear trend

Is Turtle trading still profitable?

Sort of. The turtles used a fairly simple type of trend following in futures and relied on massive position sizes. Wins were awesome, but losses were, too. It required the trader to be successful most times. Downdrafts were very punitive. Turtle strategies are strongly modified now so that downdrafts are more manageable.

How do you identify a trend in equities trading?

Open a daily chart. Arrange 4 Moving Averages sequentially from 200, 100, 50, and 18. A trend creates a clear fan. Crossover points between averages or pullbacks to averages indicate good entry points. (see chart above).

Can you use Call Options or Put Options for Trend Following?

Yes. Use 3-6 months out. Roll up to follow price and cut risk, roll out to limit time decay. See this.

What are the best trend following books?

Turtle Traders, by

Trend Following Guide

Trends and Deviation

This is a rough work-up from a great class I did, so please excuse that they’re a bit undetailed.

Find the central tendency, and buy below / sell above.

  • Create 4 ema (exponential moving average) indicators of 18, 50, 100, and 200 day ema’s. To indicate a clear trend, they need to be in sequence 18 at top, 200 at bottom, evenly spaced, not crossing. Reverse for downtrend – 18 at bottom. 18X50 is an intermediate term trade signal. Short-term is price action itself – when price crosses an EMA on a pullback, that’s an entry signal. The longer the moving average and the stronger the trend length, the better the signal. EMA’s show trends if properly configured and have predictive value, if properly used. Trends are more likely to continue than to reverse.
  • Entry – breaches of the average (50, 100, or 200) seldom exceeds 5%. IMPORTANT – if one average is breached, then the next provides very solid support.
10 year SPY chart – monthlies

This is the SPY on a 10 year, monthly period chart. (Usually you use dailies, but this makes a point, so bear with me.) In 2016, 2018, and 2020, the SPY touched 50 period ema and bounced hard. (Okay, in 2020, it broke through, but, hey – Covid 19 and shit – am I right?) It would have been painful, and stupid, to enter after it broke down below the 50, but when price crossed back up, it made a lot of sense. Every bounce is super powerful. That’s trend following in a nutshell.

Problems with Trend Following

Disregarding randomness and using TA to think the price will definitely go in a certain way if the system is strong enough, but randomness will never allow 100% certainty.  Technical triggers do not dictate ensuing market moves – they are random. The key is to manage risk and get into higher probability trades with higher reward potential. Separate probable patterns from random movement.

You, the trader, MUST determine good entry points, then monitor if adverse movements are constructive, and finally determine price reversals (end of trend). An established trend is statistically more likely to continue than reverse. Assume the truth of trend PLUS low-risk entry PLUS market neutral position (not biased to short or long) within the normal deviation.

Market timing – using technical tools to get an edge and find the most probable outcome – not guessing outcome. Forecasting is hope/fear bullshit. This is more along the lines of statistical edges.

ENTER a trend following position – method 1

  • EMA fan Continuation pattern.
  • Bar reversal pattern – key. A long wick is good, especially with a preceding move in the same direction.
Lines don’t cross

After a strong, smooth pullback: the wick creates S/R near EMA, next candle wick crosses EMA S/R, but body does not. Logic of Reversal: Test of prior low, Test of EMA.

Conservative Entry point

Entry – Next period, set entry at surpassing the previous High (Low for short) – confirmation of continuation. Set stops at prior pivot point -2 cents – if you like stops. I don’t. I prefer options for trend following.

ENTER a trend following position – method 2 – bounce pattern

Deeper pullback

EMA fan Bounce pattern – preferred setup. 18 ema (or price) dips to lower fan leg. Here the 18 ema (red line, crosses the 50 (blue), when it recrosses upward, that’s a solid entry signal.

Place an entry stop 2 cents above (long) or below (short) the reversal interval – the entire current pivot bar (Confirmation of resumption of trend). OR buy an ITM call 3-6 months out, depending on your time frame. Stops trigger too much for my taste. I’ve been stopped out of great trades and I like the elasticity and other factors of options.

Trade Management

Follow-through on Continuation pattern – Triggers occur in basing pattern, but we don’t know if market will follow through. Understanding base consolidation – we want to see price break above consolidation highs and above the 18 ema.

EMA fan must remain in effect, looking for S/R breakouts. Looking for base breakouts – 52 week high/low.

Follow-through on Bounce pattern – We’re looking for breakout: above the Reversal, any fan legs, S/R levels, or 52 week H/L’s. Reversals (bounce pattern) often shoot MUCH higher as opposed to continuation pattern.

Take positions that show strong trend via ema fan. Trade low-risk entries with strong possibilities to carry trades to multiples of the initial risk paramaters.

Intuitive Trade Management – Establish initial risk. As new pivots establish, move stops up to just below new pivots to lessen risk and lock in profit. OR roll options up with and out with time. Keep 2 months of expiration.

  • Develop your own trend following style, but be consistent.
  • Look for multiple bounces on ema line (respecting the ema).
  • Don’t catch a falling knife – wait for reversal.
  • Looking for Relative strength – RSI – RSI is 0-100 and measures the stock against others in a percentile scale – 90 RSI is strongest, of course.
  • Careful of earnings and mergers.
  • Pick a setup – choose a timeframe
  • Be SPECIFIC about setup STRUCTURE
  • Focus on setup, not result
  • work in 10-20 ticker batches
  • Risk very little until consistent

Low-Risk set-ups for Trend Following

  1. Tiny Triggers – Tiny Doji’s and Shadows signaling a probable bottom. Confine risk to 1 bar – a few cents below the bottom of the doji reversal. Great for very low risk because the doji is so small.
  2. Double Reversal – Bounce off longer ema, reverse off next upper ema, then bounce off 1st again. Price ping pongs between – low at 50, back to 18 ema, down to 50 again and bounces back up.
  3. Double EMA bounce – Consecutive days with shadow, but not body crossing the EMA. Signals high probability of staying on the good side of EMA. Very frequent on the 50.
  4. Double EMA S/R – Test of 2 EMA’s simultaneously (when they are close together) on a single candle. Works great when shadow crosses 2 EMA’s with body not crossing.
  5. Long-term surfing – 3 or more tests off the EMA. Indicates Institutional buying.
  6. Combos – 2 or more low-risk patterns. One way is combine Tiny Trigger with any other pattern.

Trend Following Scanner Setups

  • 18 ema bounce – 18/50 MACD above signal line and above Zero line PLUS 50/100 above signal and Zero line. I don’t use MACD, but you may.
  • 50/100/200 ema bounce – 50/100 MACD above signal and above Zero-line. I like wicking below these as the best signal.
  • 18 ema bounce down from 52 week high – 90% win rate (he claims). Shorting trade. When the 18 ema line bounces off a 52 week high, strong likelihood of reversal.
  • early cycle entries do better (after MACD cross or ema fan evolution). Watch for a fan developing.
  • Price action reversal Patterns – Price action test – Only wick crosses ema.
  • Price action trade-through – 2 candle bodies crossing ema – 1st closes below, next closes above.
  • Entry stop a few cents above the reversal high – strong if no upper wick.

Using Options for Trend Following Positions

Longing – 4-6 months out. Sell before 2 months out. .8 delta, liquid.

Diagonal spreads – 7:10 ratio. 7 near month closer to the money options and 10 further out and deeper in the money. Spreads will dramatically lower the returns and the risk. Let theta (time decay) balance between short and long positions. This allows the option trade to operate without premium decay penalty.

You can use weeklies with delta 1, but it needs more management. (no premium or very, very little) and roll them. You can often set your risk limit without stops only using the option this way.

Market Neutral Option Structures

  • covered calls
  • call spreads
  • calendar spreads
  • risk reversals (with downside protection)

Anatomy of a Doubler

  • IPO in last 3 years
  • Doubling in last year
  • Float less than 100 million shares (short squeeze)
  • No Debt
  • Cutting Edge Industry
  • EMA Fan continuation pattern, not bounce

Price Action Bounce System

  • Countertrend – 50ema>18 ema>100>200 (18 has dipped on a moderate pullback).
  • <2 lower lows – indicates stronger possibility of reversal
  • THEN 18X50ema again
  • THEN price pullback to 50 ema, max of 2 lower lows.
  • Test / Trade-through of 18+50.
  • 18-50 MACD favorable momentum (if you use MACD).
Setup Trend Trading Bounce
3 setups, with great follow-through

Watchlists

This is a list of strong likelihood stocks for a trend following trade.

  • Investor’s business Daily 85-85 Index – watchlist of strong stocks. Exclude stocks with average volume below 100k. Long Call candidates. High performance, mid and large cap. List requires $$.
  • Momentum scan – 250k ADV (Average Daily Volume), RSI 90+, Price $15+, price doubling in last year. Long Calls.
  • Speculative Momentum – RSI – 99+, <$16, ADV 250k, Price double in last year. Largest Historical gainers. No options available.
  • Blue-chip – DOW 30, NASDAQ 100, SP 100 – Spreads, covered calls, etc.

Pulling the Trigger

  • Focus on the setup, especially the ema fan as the highest probability
  • Delta-neutral option positions + probable market direction = maximum probability of success
  • Leveraged Directional Positions + Low Risk Continuation Entry = Controlled Risk and Unlimited potential – this is the heartbeat of the system.

Summary

  • Randomness – follow-through is random. Use random movements to enter low-risk.
  • Truth of the Trend – trends continue more likely.
  • EMA Fan – strongest trend setup. TRADE the FAN.
  • 2 bar reversal pattern.
  • Learn to intuit randomly occurring low risk setups.
  • Options – the best strategies. Directional (expecting a quick move) or delta neutral (slow move).
  • Options target window – widest window possible for delta-neutral profits. You have to balance duration with premium cost, of course.
  • EMA Fan success equations – Delta Neutral and probable direction and low-risk = high profit potential.

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SCRIPT for TOS 

If you want to plug this into Think or Swim charts, here is the code. I haven’t done it and I doubt you need it, but if you want, here ’tis.

MovAvgExponential(“length” = 18) is greater than MovAvgExponential(“length” = 50) and

MovAvgExponential(“length” = 50) is greater than MovAvgExponential(“length” = 100) and

MovAvgExponential(“length” = 100) is greater than MovAvgExponential(“length” = 200) and

low crosses below MovAvgExponential(“length” = 18)

Potential Strategies

Follow the trend – GOOG options, ITM options on other stocks, etc.

OR – sell Bull Put Spreads on stable-ish stock (AAPL)

Calendar spreads / diagonals

FAANG stocks. Exon – bought by Central Banks – what are they buying? CB’s balance sheets.

TSLA, PCLN

Bollinger Bands gauge volatility of instrument (not implied) – buy when they are narrow, sell when they are wide.

Penetrations of moving averages alternate – shallow / deep – useful for setting stops and other things.

Trend Following Tips

  • FORMULA = (Stock price) x (Annualized Implied Volatility) x (Square Root of [days to expiration / 365]) = 1 standard deviation.
  • Call/Put plays – 50ema above 100ema – buy calls. 50 below – buy puts. I’d go with 20/90’s to get in earlier. Could confirm with Volume by OBV indicator – up/down slope is the only concern.
  • Reversal – Head and shoulders are a higher probability pattern than double and triple tops, and typically provide a better risk-to-reward profile. That’s for a short position, obviously.
  • S/R often happens at round numbers because people like them and set orders there.
  • Breakout – use 90 day sma for entry signal (some data crunching thing). (I don’t trade breakouts. I think it’s mostly just traders pushing the price up and it’s really easy to get stuffed. Most breakouts fail and you have to close out quickly. I hate trading that fast, so I avoid this type of trading, but maybe you like it.)
  • 50 day moving average MUST be above 100 day – dominant trend.
  • Stocks – ONLY longs work. At most 20 positions. Scan aggressively for trending stocks.
  • Entry – new 50 day high(?). Crypto – MUCH  briefer time frame. New 5 day high? 10 day?
  • Ed Seykota (great trader – study) – Position size is more important than entry / exit points. (Money Management)
  • Stick to rules in tough times. (discipline).
  • LIKE IT! – Buy crashes after checking for positive news. (NO biotech). Especially a crash after a good earnings report. Check the long-term trend, of course. (Theory – funds use earnings to drop the price and get more shares at a lower price.)

Rules from Richard Donchian (very old rules):

  1. Don’t act on popular opinion
  2. When dull stocks begin moving, follow in the higher volume direction
  3. Limit losses / ride profits irrespective of all other rules
  4. Small commitments in uncertain conditions
  5. Don’t enter on top of a 3-day move
  6. Stops used with good S/R
  7. If up and down swings are equal – then ups lead to bigger gains (1/2 of 100 is 50 profit. Twice of 100 is 100 profit.) Go Long if Possible.

Technical Guidelines

  1. C:\Users\Daniel\AppData\Local\Microsoft\Windows\Temporary Internet Files\Content.IE5\FOTP1HKF\Emblem-star[1].pngA move followed by a sideways move frequently leads to another move as strong as the previous.
  2. S/R / reversals at previous sideways levels, approaching previous highs / lows.
  3. Trend lines – good buying / selling opps (check volume – low is good).
  4. Crawling along trends leads to breaking them.
  5. Breaking of minor countertrend lines is a position taking signal for return to dominant trend.
  6. Triangles usually break on the flat side. (higher lows or lower highs).
  7. Volume climax signals end of move.
  8. Gaps – Don’t always close –which type – breakaway, normal, or exhaustion.
  9. During a move, take or increase positions in the direction of the move after one-day reversals (even if slight), especially on low volume.

My lazy method of Trend Following

Basically, I don’t want to sit and trade all day. So instead of eyeing the current setups, I look for tickers that have done the first part, and enter a trigger at a likely second part. I’ll use options if possible, but not spreads because good fills on automated orders will never succeed on two legs, except maybe SPY or QQQ options. I’ll only go for the long leg. After it triggers, I’ll see it and put in an order for the short side.

Scan: I use finviz for screening. Select criteria

  • above 500k average volume = reasonably liquid
  • optionable = option possibilities for trading. Not necessary for lower priced tickers
  • maybe use – Dividend yield positive = more stable stock
  • Price below 20sma = recent pullback, trigger setup
  • Price above 200sma = long-term uptrend

Here are some good parameters filled out already.

Look for some regular pattern of up and down. This one jumped out at me:

Trend Following setup
finviz credit

It’s got a nice, steady trend with a pullback that’s still above the most recent low. I’d pick out up to ten tickers that appeal, then plug them into my Trader’s Workstation and go deeper.

Trend trading chart
BNTX long trend

So this chart goes back to the beginning. Biontech is a new company that IPO’d about 8 months ago. The Covid crash didn’t affect it too bad, so that’s a good sign. The trend is up with good repeat support – good. Every time it pokes the 100 ema, it spikes back up quickly – great. The tops are not rising as fast – less good, but they’re higher, except for that one spike – probably a news event, but I don’t care enough to check. Anyway, higher highs and higher lows – check.

I wouldn’t take this trade because biotech is too unpredictable. It’s not on the dividend list, either.

The next is DEA. The setup is so good, I think I’d put in an order except the day’s over.

DEA

What I like: look at that beautiful steady uptrend before Covid. During the CV crash, I pretty much discount the signals. It was panic and manipulation, so it doesn’t mean much. But look at the rise, then a second pullback right to the 200 ema. It drops below for 2 days, then pops right out. This bitch is ready to ride and slowly steady out. My guess. The price point is appealing for 100 shares or so. The option chain sux, so I’d skip right now because I’m not too interested otherwise.

Conclusion

Basically, trend trading with stocks is a bit different from futures. I’ve never trend traded futures (that’s what the Turtles did) so I can’t speak to it. But with stocks the fan setup is good – it’s not too detailed and it gives a very clear visual that’s easy to read. When the price crosses below, set a stop-loss above for entry a little bit above the 100 or 200 sma. Then when it crosses back, you enter.

Trend following is an evergreen system. Stocks and other equities will always trend. You just have to find the trend you’re comfortable with: up or down, and a timeline: a few weeks to several years. Then figure out if you can option your way in or if you want to go with straight stocks.

Good luck!

Related – Selling puts for Income – a detailed guide.