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The traditional investment paradigm often revolves around a balanced portfolio of equities and bonds. While this approach has served many investors well, it is not without its limitations. In recent years, a growing number of investors have turned their attention to alternative strategies, with trend following emerging as a compelling option.

Trend following is an investment strategy that aims to capitalise on the persistence of price trends in various markets. It involves taking long positions in assets that are trending upwards and short positions in those trending downwards. This approach stands in contrast to traditional buy-and-hold strategies, which focus on long-term ownership of assets.

1. Diversification: One of the most significant advantages of trend following is its ability to offer diversification benefits. By investing across a wide range of asset classes, including equities, bonds, commodities, and currencies, trend following strategies can reduce portfolio volatility. This is because different asset classes often exhibit low or even negative correlations with each other, meaning they tend to move in different directions.

2. Risk Mitigation: Trend following has a potential to mitigate downside risk. By going short in declining markets, the strategy can offset losses from long positions. This can be particularly valuable during periods of market turmoil.

3. Capture of Market Trends: By design, trend following seeks to profit from both uptrends and downtrends. This contrasts with traditional equity-focused portfolios that can only benefit from rising markets.

4. Absolute Returns: While not guaranteed, trend following strategies aim to generate positive returns in both rising and falling markets. This can be attractive to investors seeking uncorrelated returns.

Trend following strategies typically rely on technical analysis to identify and capitalise on market trends. Various indicators, such as moving averages and momentum oscillators, are used to generate buy and sell signals. These signals are then used to determine which assets to hold long or short.

Risk management is a crucial component of trend following. Position sizing, stop-loss orders, and diversification across multiple markets are essential to protect against adverse price movements. Additionally, trend following strategies often involve careful consideration of transaction costs, as frequent trading can impact overall performance

Asset diversification is a cornerstone of sound investment planning. Traditional diversification often focuses on combining different asset classes, such as stocks, bonds, and real estate. Trend following can complement this approach by providing exposure to a broader range of markets, including commodities and currencies.

By incorporating trend following into a portfolio, investors can potentially improve diversification benefits and reduce overall risk. This is because trend following strategies often have low correlations with traditional asset classes, which can help to smooth out portfolio returns.

1. Core satellite approach: A core-satellite portfolio involves allocating a significant portion of assets to a traditional core portfolio of stocks and bonds, with a smaller portion invested in alternative strategies, such as trend following. This approach allows investors to benefit from the stability of the core portfolio while also capturing potential upside from trend following.

2. Tactical asset allocation: Trend following can be used as a tactical asset allocation tool to adjust portfolio weights based on market conditions. For example, if equity markets are trending downwards, an investor might increase their allocation to a trend following strategy to hedge against potential losses.

3. Retirement planning: Trend following can be incorporated into retirement plans to help manage risk and generate income. By providing a potential source of uncorrelated returns, trend following can help to improve the overall risk-adjusted return of a retirement portfolio

While trend following offers several potential benefits, it is essential to consider the following:

1. Performance: Past performance is not indicative of future results. Trend following strategies can experience periods of underperformance.

2. Fees: Trend following strategies often involve higher fees than traditional investment approaches.

3. Complexity: Understanding and implementing trend following strategies can be complex and requires specialised knowledge.

4. Market Conditions: Trend following strategies may not be effective in all market conditions. For example, during periods of market stagnation or sideways movement, performance may be limited.

Trend following represents an intriguing investment strategy that offers the potential for diversification, risk mitigation, and absolute returns. By carefully considering the benefits and challenges, investors can determine if trend following is a suitable addition to their investment portfolio. It is essential to conduct thorough research and consider consulting with a financial advisor before making any investment decisions.