How to be a Successful Trend-Following Futures Trader

When evaluating strategies for day trading, perhaps the most common theme you will encounter is “following the trend.” Being a trend-following trader is one of the easier ways to trade. It means that you take trades that fall in line with the more powerful, established trends in the market, while skipping the trades that don’t.

This approach is simpler than others, and can be less stressful as well. When there isn’t a clear trend, traders simply sit on the sidelines, not taking the risk of trading in unclear market conditions. Not everyone trades this way, but it’s safe to say that most traders do, and for good reason.

Some will tell you that you need to learn to “beat the crowd” to be successful, but this is simply not the case. Make no mistake: doing what nobody else is doing would have made you quite a lot of money if you were shorting at the top just before Covid-19 really hit. But if you were consistently going long from 2009-2020, you would have made a fortune as well. If you’re here to develop long-term, sustainable growth, it’s unwise to rely on a blockbuster trade in an exceptional situation for your success.

In this article, we’re going to take a look at how you can apply trend-following concepts to your futures trading for less stressful, and often more profitable results.

A Quick Lesson From the Big Short and the 2008 Housing Market Collapse

Successful traders understand that markets can sometimes be quite unpredictable. If you’ve watched The Big Short, you caught a glimpse of how the market can behave irrationally, in favor of continuing its long-term trend.

Even though Michael Burry (played by Matthew McConaughey) was correct in his assessment that the housing market would collapse to correct itself, it didn’t happen right when he placed his trades. In fact, even when the market began to fail, the price of his credit default swaps were still not making any profit. This would go on for several months, costing him and other traders millions in fees, as the market continued to go up against their position.

Why did this happen, even if several people correctly determined that the market was extremely overpriced?

The reason is that the the market had been bullish for over 15 years at that point. The trend had clearly been established, and was simply continuing as it had been.

When a trend is so powerful that it’s been going on for decades, it doesn’t stop the moment something is wrong. It often continues in the same direction for much longer. Then, when months or years of overbuying or overselling have accumulated, a massive correction seemingly happens overnight.

Millions of traders and investors had piled on profits month after month, year after year, pushing prices higher and keeping the trend going. In the movie, and likely in real life as well, some people working with mortgages even bragged about how easily the money was coming in.

So what’s the lesson?

Credit default swaps and other complex options trades are not the focus of this article. And I’m not saying that you need to join the banks in committing fraud at the expense of the American consumer, either.

But The Big Short illustrates just how difficult it can be to trade against the market, even if you’re 100% right and the whole country is wrong. This is why it’s important to know that the trend is bullish, even if signs are pointing toward a market collapse. Having this knowledge is especially useful for day traders. An astute trader would have capitalized on this bullish trend for months, taking profits each day, by simply trading with the trend.

Being aware of this concept will help you manage positions and your mental state easier. We can only imagine how stressed Michael Burry was in that position, and 99.9% of traders would have accepted the loss before finally reaping the rewards of that life-changing trade.

If we’re here to establish a consistent, successful approach to trading, it’s important to incorporate some of the trend-following concepts in your own strategy. So how can you apply this concept to your own trading?

Even If The Market Doesn’t Make Sense, Follow the Prevailing Trend

Imagine you’re trading in the 90s. Watching the market for months, you have a gut feeling that the tech bubble is already too big. “The market doesn’t make sense“, you think to yourself. “It cannot sustain this kind of growth forever. It has to come down.”

You arrive at your trading desk. It’s October 14, 1999. The market is soaring again, and you have still not taken a long position. What are you going to do? Are you going to deny the trend that’s been pushing the market higher for years, because of your (correct) assessment that the market is already too high? Will you continue to wait until you get your chance to short it, and say you were right all along? Or will you capitalize on what’s happening right in front of you, right now?

Plenty traders made the same assessment about the market, even back then. All of them would have lost money by going short too soon.

It’s moments like these where trend-following makes the most sense. Are we in this business to be right all the time? Or are we here to place responsible trades that will net us a profit, as consistently as we can? It’s not uncommon that traders get fixated on being right.

You could wait until the best moment and go short, and some do. But I believe that if you are pursuing trading mastery, you will take advantage of the trend that is in front of you, first, and worry about the reversal when it is ready.

This is a simple example, of course. If you’re looking to build a specific strategy based on trend-following, I will be sharing another article on that shortly. But for now, let’s take a look at some of the drawbacks of this approach.

The Challenges of Trend-Following

Just like most strategies, trend-following isn’t perfect. There are certainly drawbacks and difficult moments, which should be apparent, because not every successful trader trades this way.

Most of the challenges are purely mental. Nonetheless, they can easily sabotage your goals of a profitable career if you’re not prepared.

Trusting the Trend During a Drawdown

When you are facing a drawdown, even during an established trend, you might find yourself second-guessing your judgment. “Why didn’t I wait for this dip? I’m going to lose even more money if I wait longer. What if I’m wrong and this isn’t the actual trend?”

At its worst, you may be forced out of your trade, because your entry was subpar and the drawdown was steep. After you exit with a sizeable loss, the trend eventually pulls the price back up, and the train lumbers ahead on the same track, without you.

Trusting the underlying trend to continue in the same direction, while you are facing a drawdown, is not a fun experience. It’s easier when you have good risk management in place, but it’s still not fun to see red positions. Staring at the red, hour after hour, day after day, while trying to convince yourself that you made the right trade, is not easy. This can be uncomfortable and stressful, especially for newer traders.

But in the end, as a trend-trader, you will go through it. Unless you’re already a master, you will undoubtedly enter some trades just before the drawdown. If your risk management is poor, you’ll take a loss, and maybe even miss the reversal when it’s ready.

The good news? It might not matter. If you’re able to trust that you read the trend correctly, you will continue to find good opportunities to profit until the trend changes.

Accepting That You Will Probably Miss the Superstar Trades

Nobody is shocked when you tell them that you made money by going long on AAPL from 2000 to 2020. Of course you did. So did everyone else who bought it. But are you going to complain about the fact that you did something everyone else did, and made money?

This may seem ridiculous to complain about, but it’s definitely a reality. Some traders are not satisfied by this conclusion. They feel bored by going with the crowd, and prefer a strategy that is centered around reversals. If this is you, then you want to be the one who went short when Covid-19 first shutdown the American economy in 2020.

But if you want to be a trend-following trader, you’ll have to accept that you simply won’t catch those sharp reversal moves. You’ll be sitting out until it’s clear that the trend has shifted, and likely enter your short position late. You’ll make your money, but it might be less than what those superstar once-in-a-lifetime traders walk away with. And you won’t be able to say “I told you so.”

Learning When and How to Change Course

So you’ve traded for months with a particular market and trend, and made a nice sum. Suddenly, the trend changes. A CEO steps down, or lab test results are terrible, and a once-promising drug is abandoned. Your primary source of easy trades vanishes. What now?

One of the most difficult aspects in all of trading is knowing how to identify that a market condition has changed. If people could do it easily, they’d all become reversal traders, and millionaires in a week.

Recognizing that the trend has changed, and being willing to accept it immediately and exit your position, is an important skill to develop. You may even consider entering another position in the opposite direction, too, if you’re experienced enough to adjust on the fly.

Imagine getting comfortable with regular profits, being long in the dot com bubble for several years. Are you willing to recognize that a trend like that may no longer be viable? Will you let go of any attachment to that particular market or whatever strategy you had employed to profit from its trend? If you can, you will fare better than most of your competition. If not, well, you might have to wait years for prices to return to break even, if they ever do.

How to Follow the Trend: A Futures Day Trade Example

Hopefully you have an idea of the kind of mindset you need to be a trend-following trader. But how do you actually use this philosophy to place a good trade in futures?

I’ve put together this example below to show you how you can recognize the trend in a futures market, and trade accordingly.

Step 1: Identify the trend on the higher time frame.

If you’re day trading NQ or ES futures, you are most likely confined to the 6.5 hours that the US Stock Market is open, from 9:30 AM to 4:00 PM EST. Thus, we will need to rely on the hourly chart for much of our analysis of market direction.

Open up your 1-Hour and 4-Hour charts, and take a note of the underlying, long term trend. If you don’t find a clear trend, it might be that the market doesn’t have one at this time. But most of the time, it should be easy to determine. It’s said that a 5-year old can look at a candle chart and tell you whether it’s going up or down, so you should be able to do the same.

It looks like the trend is up. What’s next?

Step 2: Locate potential areas of significance on the lower time frame.

To capture the most profit while following a trend, traders must analyze multiple timeframes to identify high-probability trade setups and confirm the validity of market trends. By examining both long-term and short-term charts, a trend-following trader can try to find a good point to get in sync with the larger trend.

Step 3: Take profits at your predefined levels, and wait for the next opportunity.