No one invests without an expectation of future profit. Even professional CTAs invest with the hope that strategies they employ after back testing will be profitable over the long run. More generally, they often believe that the financial markets they trade will continue to have exploitable trends for their foreseeable existence. Thus, trend followers have intelligent assumptions about the future backing up their application of their strategies. They often make the entire trade planning process completely mechanical, from choosing which instruments they trade to timing their entries, sizing their positions, and timing their exits. However, there’s no rule that requires you to time all of your entries with a trend following strategy in order to size your positions and time your exits with such a strategy. You can easily mix a fundamentals based entry with a trend following exit method, for example. For this reason, I broadly define a trend following trading strategy as in the box.
Any pre-planned, rule-based strategy for managing open position P&L in which open profits could hypothetically grow indefinitely under a limited set of circumstances, while open losses are limited under all circumstancesNote that this definition is independent of your reasons for entering the market and your timing in doing so. The fact that a trend following trading method is both pre-planned and rule-based means that decisions about how to react to all possible scenarios are made before entering the market, and thus a trader using a trend following method simple reacts to prices unemotionally once in the market rather than trying to predict what prices will do next.
Note also that I define trend following as a method of managing open position P&L, that is, exits and position sizes specifically, rather than both entries and exits.
Note that in my definition, I say that in a trend following trading strategy, “open losses are limited under all circumstances,” while “open profits could hypothetically grow indefinitely under a limited set of circumstances.
Clearly, then, a trend following trading strategy can be employed to time exits in any market situation in which sustained future movement in a particular direction is expected. Correctly anticipating sustained future movement in a financial instrument is difficult enough. Correctly anticipating the exact form that this sustained movement will take is impossible.
Source: Trend Trading: Timing Market Tides (Wiley Trading), Kedrick Brown.