What are the historical origins of trend following?

 

The historical origins of trend following can be traced back to the early 20th century, with several key developments and individuals contributing to the establishment and evolution of the strategy:

 

1. Charles Dow and Dow Theory (Late 19th to Early 20th Century)
- Charles Dow: A founding figure in the field of technical analysis, Charles Dow developed Dow Theory, which laid the groundwork for trend following.
- Dow Theory Principles: Dow's theory proposed that markets move in trends (primary, secondary, and minor trends), and these trends could be identified and followed. This theory emphasized the importance of analyzing price movements and market trends rather than relying solely on fundamental analysis.

 

2. Richard Donchian (Mid-20th Century)
- Father of Trend Following: Richard Donchian is often credited as the "father of trend following." He introduced systematic approaches to trading and emphasized the importance of following trends.
- Donchian Channels: Donchian developed the concept of Donchian Channels, a technical indicator that identifies the highest high and lowest low over a specified period. This indicator helps traders identify breakouts and trends.
- Managed Futures Fund: In 1949, Donchian established one of the first managed futures funds, the Futures, Inc., which used trend-following principles to trade commodities.

 

3. Turtle Traders Experiment (1980s)
- Richard Dennis and William Eckhardt: In the 1980s, Richard Dennis, a successful commodities trader, and his partner William Eckhardt conducted an experiment to determine whether trading success could be taught.
- The Turtles: They recruited a group of individuals, known as the Turtle Traders, and taught them a systematic trend-following strategy. The Turtles used predefined rules for entry, exit, and risk management, proving that trend following could be successfully taught and implemented by disciplined traders.
- Legacy: The success of the Turtles solidified the legitimacy of trend following and demonstrated its potential for consistent profitability.

 

4. Development of Technical Analysis Tools (20th Century)
- Technical Indicators: Throughout the 20th century, numerous technical indicators and tools were developed to aid in trend identification and following. These include moving averages, MACD, Relative Strength Index (RSI), and Average Directional Index (ADX).
- Chart Patterns: Technical analysts also identified various chart patterns, such as head and shoulders, double tops, and triangles, which help traders recognize trend continuations and reversals.

 

5. Rise of Managed Futures and Commodity Trading Advisors (CTAs)
- Managed Futures Industry: The 1970s and 1980s saw the rise of the managed futures industry, where professional money managers, known as Commodity Trading Advisors (CTAs), used trend-following strategies to trade futures markets.
- Systematic Trading: CTAs and managed futures funds embraced systematic trading approaches, relying on computer algorithms and models to identify trends and execute trades. This period marked the integration of technology and quantitative analysis into trend following.

 

6. Influential Books and Publications
- "Reminiscences of a Stock Operator" (1923): This book, based on the life of legendary trader Jesse Livermore, highlighted the importance of following market trends and avoiding the pitfalls of prediction.
- "A Random Walk Down Wall Street" (1973): Burton Malkiel's book popularized the idea that markets are efficient, indirectly supporting the notion that following trends (rather than predicting them) can be a viable strategy.
- "Market Wizards" Series: Jack D. Schwager's series of books featured interviews with successful traders, many of whom employed trend-following strategies. These books provided insights into the principles and practices of trend following.

 

7. Adoption by Hedge Funds and Institutional Traders
- Institutional Adoption: By the late 20th and early 21st centuries, trend following was widely adopted by hedge funds and institutional traders. Notable funds, such as John W. Henry & Company, used trend-following strategies to achieve significant returns.
- Diverse Markets: Trend following expanded beyond traditional commodities and futures markets to include equities, Forex, and more recently, cryptocurrencies.
 

Conclusion
The historical development of trend following is a testament to its enduring relevance and adaptability. From the foundational theories of Charles Dow to the systematic approaches pioneered by Richard Donchian and the empirical validation provided by the Turtle Traders, trend following has evolved into a robust and widely respected trading strategy. Its success across various market conditions and asset classes continues to attract traders and investors seeking a systematic approach to capturing market trends.

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