What is meant by “trend following”?

Trend following, or trend trading, is a very appealing concept because of its very simplicity. The idea is to buy an asset when its price is rising and sell an asset short when its price is falling: the expectation is that prices have momentum, which carries in them the same direction they were going in the recent past.

With trend trading, you can expect a lot of false starts. Every blip, needless to say, does not constitute the start of a new trend. However, if you can get in early on one or two big trends and ride them, this strategy can be highly profitable. 

Source: The HedgeFundJournal

Implementing this trading strategy is easier said than done. Beginner forex traders should be aware of the steep learning curve involved.

This is largely because there are many different ways to identify a trend. Trends can be spotted by relying on various measures of price calculation, volatility, and technical indicators like moving averages. In fact, depending on the timeframe involved, there is often disagreement among analysts about whether the price trend is up, down or sideways!

Revisiting the basics of ETFs

Exchange Traded Funds (ETFs) are investment funds divided into shares that are traded on a stock exchange. ETFs hold financial assets such as stocks, bonds, and/or commodities and usually aim to track the performance of specific indexes.

ETFs are popular investment vehicles for a number of reasons:

• Tradability: ETFs can be bought and sold during trading hours, just like individual stocks.
• Diversification: ETFs provide instant access to a diversified portfolio, as they often track a broad-based index.
• Transparency: ETFs disclose their holdings daily, providing transparency to investors.

Advantages of relying on money managers

In the long run, smart money always outperforms dumb money. It’s for this reason that investors turn to trend-following experts for guidance on how to “trade the trend”.

Professionals who manage portfolios on behalf of a pool of investors using a trend-following strategy are known as Commodity Trading Advisors (CTAs), and the funds they manage are known as managed futures.

The trouble is that access to these types of risky alternative investments, which are in effect hedge funds, is heavily gated. Oftentimes, minimum investment amounts are in the hundreds of thousands of dollars. This is understandable on the part of the fund manager: they want to attract only “sophisticated investors” who understand and can shoulder the risks. However, the net effect is that smart retail traders and investors get left out. Fortunately, a special kind of ETF addresses this gap.

The basics of managed futures

Let’s explore how these managed futures funds apply trend-following strategies. To begin with, their portfolios normally consist of exchange-traded futures contracts. (Futures are contracts where a buyer is obligated to buy, or a seller is obligated to sell, an asset at a specific date for a specified price.) 

Managed futures are deliberately as diversified as possible and often include almost every asset class. Usually, the largest component of the funds comprises either long or short forex (foreign currencies) positions, fixed income assets (bonds), and commodities. 

These funds invest in all these different asset classes so they can be exposed to as many potential price trends as possible. The big advantage to investors is that these funds’ returns are typically non-correlated with the stock market. In other words, investors can use them to hedge their portfolios and add another layer of diversification.

Source: Pimco

The funds use a pre-defined set of mathematical rules and formulas to determine when to buy and when to sell their investments. These trading systems are carefully devised and refined by backtesting them on past price action and measures of volatility. 

While fund managers won’t ever give away proprietary information on how their strategies work, they are not so-called “black boxes”. The basic premise is still trading the momentum, combined with strong risk management. Common techniques include buying at multi-day highs or selling at multi-day lows, and closing the position when realised volatility rises beyond a certain limit.

How trends are identified

Recognising a trend before others figure it out can be hugely profitable; mistaking a random price movement for a trend can be disastrous. Knowing the difference is crucial for successful trading. 

A trend is merely the general direction that a security or market is taking over a specified time. They are typically categorised into uptrends, downtrends and sideways/horizontal trends.

• Uptrend: This is distinguished by higher highs and higher lows. In simple terms, an uptrend occurs when the price of an asset is moving higher over time, even though it still fluctuates up and down.
• Downtrend: This is the opposite of an uptrend and is marked by lower highs and lower lows. It occurs when the price of an asset is falling.
• Sideways/Horizontal trend: This happens when the forces of supply and demand are nearly balanced, so there is little overall movement in the price. Periodic rises and drops cancel one another out.

Some common tools traders use to identify trends are trendlines and moving averages. Trendlines are lines drawn over pivot highs or under pivot lows to give a visual indication of where the price is moving. Moving averages evaluate the centre value around which price fluctuations occur.

How to use managed futures ETFs

Managed futures ETFs are a good way to passively invest in exchange-traded funds without being tied to an index. 

The following table shows 3 of the largest managed futures ETFs by assets under management (AUM).

Source: ETFSDB.com

If you have an account with an online investment platform, you may want to take a moment today to see what managed futures products they offer.

Note how the asset mix, trading philosophy, and management style of these funds differ considerably. It is essential to research each thoroughly in order to find a good fit for your needs. Some of those you might encounter include:

WisdomTree Managed Futures ETF (WTMF)

WTMF utilises a systematic, rules-based methodology to capture price trends across a broad spectrum of asset classes. Its quantitative model identifies both upward and downward momentum, allowing the fund to take long or short positions accordingly. A distinct characteristic of this fund is its inclusion of Bitcoin futures, which can represent up to 10% of its exposure, offering a modern twist on the traditional trend-following model. The strategy is designed to provide “flat” or positive returns during periods when traditional stocks and bonds struggle, making it a potential hedge against systemic volatility and inflation.

First Trust Managed Futures Strategy ETF (FMF)

This fund distinguishes itself through an active management style that blends quantitative signals with qualitative oversight. While many competitors are purely algorithmic, FMF’s managers have the flexibility to navigate contract selection and rolls more dynamically. It seeks absolute returns by trading futures on global debt, currencies, and equity indexes, as well as commodities. FMF typically maintains a global reach, including exposure to emerging markets. The fund’s objective is to achieve a low correlation to the broader market, focusing on capturing economic benefits from shifting global macro trends through a highly liquid, transparent structure.

iM DBi Managed Futures Strategy ETF (DBMF)

DBMF takes a unique “top-down” approach compared to the “bottom-up” trend-following of its peers. Instead of building its own signals from scratch, it employs a replication strategy designed to mimic the pre-fee performance of many hedge funds. By using a proprietary model to identify the key drivers of these “smart money” managers, DBMF aims to provide “fee alpha” – essentially delivering hedge fund-level returns but at a significantly lower expense ratio. It focuses on the most liquid futures contracts across equities, fixed income, and currencies to minimise trading costs while capturing the consensus positioning of the industry’s top performers.

Are managed futures a good choice?

It’s rare for any investment decision to have one clearly right answer; everything depends on each person’s individual circumstances and goals. Managed futures’ low correlation with the general equity market can be a boon when stock prices are weak. Conversely, they are often outperformed by a rising market.

Managed futures ETFs also tend to be more volatile than those tracking indices, making them a poor choice if your main goal is just to guard your nest egg. Even if this is the case, though, they can still fulfil a valuable role in your portfolio, namely as a hedge against shocks in the wider market.