Guiding Principles of Trend-Following

While trend-followers believe there are elements within the buy-and-hold philosophy that are valuable, such as a long-term outlook and the belief that no one -- absolutely no one -- knows how high the market will fly or how far it will fall, they also believe there is a way to improve on the tradition.

While it is true that the stock market always goes up over the long term, there can be major losses during downtrends or bear markets that can take years to recoup. Trend-followers seek a way to minimize their exposure to such losses by using a purely mechanical way of looking at what the market is doing at the present moment and reacting in kind.

Logic, trend-followers say, is not nearly as accurate an indicator as objective data, such as price and volume movements and interactions. In addition, external information, such as earnings statements or interest rates, only make for a "confusion of voices" that tend to lead investors into emotional investing. There is no anticipation in trend-following, only reaction to what is happening now.

As such, trend-followers hold to some basic guiding principles:

• First, the market is always changing, generally moving in trends that, while not predictable, can be detected and measured.
• Second, by recognizing the change, you can react to it in ways that will make the most of an uptrend and minimize the effects of downtrends -- or better yet, benefit from them. How you recognize change is determined by the type of technical indicators you decide to follow. For example, if you are following moving averages, you'll begin to see an uptrend when a faster 50-day average crosses the slower moving 200-day moving average to the upside. When it plunges back under, you are looking at a decline in the market. Whatever methodology trend-followers use, there is no forecasting or guessing, only reaction to trends that are already occurring.
• Third, losses will occur.

Trend-followers are the first to agree that no one individual or system is always right. But for them, the goal isn't about being right. It's about making money. So if you can just check your emotions at the door and watch how the market is moving with a neutral eye, you can detect patterns, make solid decisions, manage the risk, mitigate losses and profit in either bear or bull markets.