How to Choose a Trend-Following System

At the other extreme is a system with a longer-term focus. This is the approach I favor. It's the closest thing to buy and hold, but with downside protection. My trend-following style is geared toward the long-term investor who intends to build substantial wealth by applying disciplined, nonemotional technical analysis to all, or most, serious money available. Obviously, you want to be invested in the market most of the time. But you want to be able to protect yourself against downtrends by being able to step out of the market when necessary. Or better yet, benefit in downtrends by shorting the market.

Look at What You Follow

Another way to differentiate trend-following systems is to look at what indicators they track. Michael Covel and the traders he profiles in his book, Trend Following, focus purely on price. They contend that this can be applied to anything that's traded: stocks, bonds, currencies and commodities. Other systems focus solely on the stock market and measure additional indicators such as volume.

Regardless of whether a system focuses on price only or price and volume, its model can range from very simple to exceedingly complex.

With the more complex systems, you may be getting more information than you really want or need, and the model may have been overly optimized or fitted to the observation period. When you start factoring in too many indicators, it starts to become emotion-based trading again. Which of the dozens of indicators do you favor? Which moving average do you use -- 20-day, 50-day? The problem with overly complicated trend-following models is that you begin to lose sight of the forest because there are too many trees.