One way for conservative investors to use a trend following approach is to create hedges. To create a hedge an investor can go long one type of investment, and simultaneously short another similar investment. An example of this would be to go long the Nasdaq, and short the Dow Jones.
The chart below shows the result one would attain by buying the QQQQ (Nasdaq) and shorting DIA (Dow):
The Dow and the Nasdaq are fairly closely correlated, but not perfectly correlated (if they were perfectly correlated, the above chart would be a horizontal line).
The above chart shows that the Nasdaq underperformed the Dow from September 2008 to December 2008. Therefore, money could have been made made by shorting the Nasdaq, and buying the Dow.
Since the new year, the reverse has been true, and money could have been made by buying the Nasdaq, and shorting the Dow. And using this strategy could be profitable in a rising or falling market. If the general market falls, money is made if the Dow falls more than Nasdaq and vice-versa.
Furthermore, the above chart should be treated like a single entity. So if I were to take on such a position, I would ride this relative trend until the 50dma was taken out (just as I would if I were trading a single stock).
There are many other hedges that can be created; the only requirement is some experimentation and imagination. Another example is Apple versus Microsoft:
The above chart shows that Apple is a stronger stock than Microsoft, and money could have been made by buying Apple and shorting Microsoft. This type of hedge is much more conservative than just holding Apple or just shorting Microsoft. Each side of the hedge can offer some protection in a rising and falling market, and can therefore be more conservative than even a traditional buy and hold strategy.
