# Momentum Investing

Do financial market prices reliably exhibit momentum? If so, why, and how can traders best exploit it? These blog entries relate to momentum investing/trading.

**April 3, 2020** - Momentum Investing, Value Premium

Do stock anomaly (factor premium) portfolios exhibit exploitable value and momentum? In their February 2020 paper entitled “Value and Momentum in Anomalies”, Deniz Anginer, Sugata Ray, Nejat Seyhun and Luqi Xu investigate exploitability of time variation in the predictive ability of 13 published U.S. stock accounting and price-based anomalies based on: (1) anomaly momentum (1-month premiums); and/or (2) anomaly value (adjusted average book-to-market ratios). Specifically, they each month:

- For each anomaly, form a value-weighted portfolio that is long (short) the tenth, or decile, of stocks with the highest (lowest) expected returns.
- For each long-short anomaly portfolio:
- Measure its value as last-year average book-to-market ratio minus its average of average book-to-market ratios over the previous five years.
- Measure its momentum as last-month return.

- Form a value portfolio of anomaly portfolios that holds the equal-weighted top seven based on value, rebalanced annually.
- Form a momentum portfolio of anomaly portfolios that holds the equal-weighted top seven based on momentum, rebalanced monthly.
- Form a combined value-momentum portfolio of anomaly portfolios that holds those in the top seven of both value and momentum, equal-weighted and rebalanced monthly.

Their benchmark is the equal-weighted, monthly rebalanced portfolio of all anomaly portfolios (1/N). Using data required to construct anomaly portfolios and monthly delisting-adjusted returns for U.S. common stocks excluding financial stocks and stocks priced under $1 during January 1975 through December 2014, *they find that:* Keep Reading

**March 27, 2020** - Calendar Effects, Momentum Investing

Are some calendar months more likely to exhibit stock market continuation or reversal than others, perhaps due to seasonal or fund reporting effects? In other words, is intrinsic (times series or absolute) momentum an artifact of some months or all months? To investigate, we relate U.S. stock index returns for each calendar month to those for the preceding 3, 6 and 12 months. Using monthly closes of the S&P 500 Index since December 1927 and the Russell 2000 Index since September 1987, both through January 2020, *we find that:* Keep Reading

**March 26, 2020** - Momentum Investing, Strategic Allocation, Technical Trading

A subscriber asked whether applying a simple moving average (SMA) filter to “Simple Asset Class ETF Momentum Strategy” (SACEMS) winners improves strategy performance. SACEMS each months picks winners from among the a set of eight asset class exchange-traded fund (ETF) proxies plus cash based on past returns over a specified interval. Since many technical traders use a 10-month SMA (SMA10), we test effectiveness of requiring that each winner pass an SMA10 filter by comparing performances for three scenarios:

- Baseline – SACEMS as presented at “Momentum Strategy”.
- With SMA10 Filter – Run Baseline SACEMS and then apply SMA10 filters to dividend-adjusted prices of winners. If a winner is above (below) its SMA10, hold the winner (Cash). This rule is inapplicable to Cash as a winner.
- With Half SMA10 Filter – Same as scenario 2, but, if a winner is above (below) its SMA10, hold the winner (half the winner and half cash).

We focus on compound annual growth rates (CAGR), annual Sharpe ratios and maximum drawdowns (MaxDD) of SACEMS Top 1, equally weighted (EW) Top 2 and EW Top 3 portfolios. To calculate Sharpe ratios, we use average monthly 3-month U.S. Treasury bill (T-bill) yield during a year as the risk-free rate for that year. Using monthly dividend-adjusted closing prices for the asset class proxies and the (T-bill) yield for Cash over the period February 2006 through February 2020, *we find that:* Keep Reading

**March 10, 2020** - Momentum Investing, Sentiment Indicators, Strategic Allocation, Value Premium

“Verification Tests of the Smart Money Indicator” reports performance results for a specific version of the Smart Money Indicator (SMI) stocks-bonds timing strategy, which exploits differences in futures and options positions in the S&P 500 Index, U.S. Treasury bonds and 10-year U.S. Treasury notes between institutional investors (smart money) and retail investors (dumb money). Do these sentiment-based results diversify those for the Simple Asset Class ETF Momentum Strategy (SACEMS) and the Simple Asset Class ETF Value Strategy (SACEVS)? To investigate, we look at correlations of annual returns between variations of SMI (no lag between signal and execution, 1-week lag and 2-week lag) and each of SACEMS equal-weighted (EW) Top 3 and SACEVS Best Value. We then look at average gross annual returns, standard deviations of annual returns and gross annual Sharpe ratios for the individual strategies and for equal-weighted, monthly rebalanced portfolios of the three strategies. Using gross annual returns for the strategies during 2008 through 2019, *we find that:* Keep Reading

**February 11, 2020** - Currency Trading, Momentum Investing

Do exchange-traded funds (ETF) that track major currencies support a relative momentum strategy? To investigate, we consider the following four ETFs:

Invesco DB US Dollar Bullish (UUP)

Invesco CurrencyShares Euro Currency (FXE)

Invesco CurrencyShares Japanese Yen (FXY)

WisdomTree Chinese Yuan Strategy (CYB)

We each month rank these ETFs based on past return over lookback intervals ranging from one to 12 months. We consider portfolios of past winners reformed monthly based on Top 1 and on equally weighted (EW) Top 2 and Top 3 ETFs. The benchmark portfolio is the equally weighted combination of all four ETFs. We present findings in formats similar to those used for the Simple Asset Class ETF Momentum Strategy and the Simple Asset Class ETF Value Strategy. Using monthly adjusted closing prices for the currency ETFs during March 2007 (when three become available) through December 2019, *we find that:* Keep Reading

**January 24, 2020** - Momentum Investing, Size Effect, Value Premium

“Beat the Market with Hot-Anomaly Switching?” concludes that “a trader who periodically switches to the hottest known anomaly based on a rolling window of past performance may be able to beat the market. Anomalies appear to have their own kind of momentum.” Does momentum therefore work for style-based exchange-traded funds (ETF)? To investigate, we apply a simple momentum strategy to the following six ETFs that cut across market capitalization (large, medium and small) and value versus growth:

iShares Russell 1000 Value Index (IWD) – large capitalization value stocks.

iShares Russell 1000 Growth Index (IWF) – large capitalization growth stocks.

iShares Russell Midcap Value Index (IWS) – mid-capitalization value stocks.

iShares Russell Midcap Growth Index (IWP) – mid-capitalization growth stocks.

iShares Russell 2000 Value Index (IWN) – small capitalization value stocks.

iShares Russell 2000 Growth Index (IWO) – small capitalization growth stocks.

We test a simple Top 1 strategy that allocates all funds each month to the one style ETF with the highest total return over a set momentum ranking (lookback) interval. We focus on the baseline ranking interval from the “Simple Asset Class ETF Momentum Strategy (SACEMS)”, but test sensitivity of findings to ranking intervals ranging from one to 12 months. As benchmarks, we consider an equally weighted and monthly rebalanced combination of all six style ETFs (EW All), and buying and holding S&P Depository Receipts (SPY). As an enhancement we consider holding the Top 1 style ETF (3-month U.S. Treasury bills, T-bills) when the S&P 500 Index is above (below) its 10-month simple moving average at the end of the prior month (Top 1:SMA10), with a benchmark substituting SPY for Top 1 (SPY:SMA10). We consider the performance metrics used for SACEMS. Using monthly dividend-adjusted closing prices for the six style ETFs and SPY, monthly levels of the S&P 500 index and monthly yields for T-bills during August 2001 (limited by IWS and IWP) through December 2019, *we find that:*

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**January 14, 2020** - Momentum Investing, Strategic Allocation, Technical Trading

How can investors suppress the downside of trend following strategies? In their July 2019 paper entitled “Protecting the Downside of Trend When It Is Not Your Friend”, flagged by a subscriber, Kun Yan, Edward Qian and Bryan Belton test ways to reduce downside risk of simple trend following strategies without upside sacrifice. To do so, they: (1) add an entry/exit breakout rule to a past return signal to filter out assets that are not clearly trending; and, (2) apply risk parity weights to assets, accounting for both their volatilities and correlations of their different trends. Specifically, they each month:

- Enter a long (short) position in an asset only if the sign of its past 12-month return is positive (negative), and the latest price is above (below) its recent n-day minimum (maximum). Baseline value for n is 200.
- Exit a long (short) position in an asset only if the latest price trades below (above) its recent n/2-day minimum (maximum), or the 12-month past return goes negative (positive).
- Assign weights to assets that equalize respective risk contributions to the portfolio based on both asset volatility and correlation structure, wherein covariances among assets adapt to whether an asset is trending up or down. They calculate covariances based on monthly returns from an expanding (inception-to-date) window with baseline 2-year half-life exponential decay.
- Impose a 10% annual portfolio volatility target.

Their benchmark is a simpler strategy that uses only past 12-month return for trend signals and inverse volatility weighting with annual volatility target 40% for each asset. Their asset universe consists of 66 futures/forwards. They roll futures to next nearest contracts on the first day of the expiration month. They calculate returns to currency forwards using spot exchange rates adjusted for carry. Using daily prices for 23 commodity futures, 13 equity index futures, 11 government bond futures and 19 developed and emerging markets currency forwards as available during August 1959 through December 2017, *they find that:* Keep Reading

**December 26, 2019** - Momentum Investing

What is the best way to balance crash protection and false alarms for intrinsic, also called absolute or time series, momentum strategies that are long (short) an asset when its return over a specified past interval is positive (negative)? In their November 2019 paper entitled “Momentum Turning Points”, Ashish Garg, Christian Goulding, Campbell Harvey and Michele Mazzoleni investigate blending slow and fast intrinsic momentum signals with various weights on each (adding to one) to identify the best way to handle reversals in trend direction. They specify a slow (fast) signal as that derived from past 12-month (1-month) excess return. They define four market states: (1) Bull (slow and fast signals both non-negative); (2) Correction (slow signal non-negative and fast signal negative); (3) Bear (slow and fast signals both negative); and, (4) Rebound (slow signal negative and fast signal non-negative). They first consider static weights in increments of 25% for slow and fast signals. They then consider a dynamic strategy with slow and fast signal weights that differ for Correction and Rebound states as identified with monthly data. They test usefulness of the dynamic strategy by optimizing weights with historical returns and then evaluating performance of these weights out-of-sample. While focusing on the U.S. stock market, they test robustness of findings across other developed country equity markets. Using monthly excess returns for the U.S. value-weighted stock market since July 1926 and for 10 other developed stock markets since February 1980, all through December 2018, *they find that:*

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**December 20, 2019** - Animal Spirits, Individual Investing, Momentum Investing

Is retail trading a reliable driver of U.S. stock momentum? In his November 2019 paper entitled “Retail Trading and Momentum Profitability”, Douglas Chung investigates interactions across stocks between current proportion of retail trading and future momentum returns. Specifically, for each month and for each of two recent stock samples, he:

- Sorts stocks into fifths (quintiles) by current proportion of retail trading.
- Within each proportion-of-retail-trading quintile:
- Sorts stocks into sub-quintiles by return from 12 months ago to one month ago.
- Calculates average next-month returns for an equal-weighted momentum portfolio that is long (short) the sub-quintile of stocks with the highest (lowest) past returns. He also considers other portfolio weighting schemes.
- Measures alphas of these returns based on various widely accepted single-factor and multi-factor models of stock returns.

He next tests whether proportion of retail trading relates to a gambling motive (lottery trading) by constructing a stock lottery index from inverse of stock price, idiosyncratic volatility, idiosyncratic skewness and recent maximum daily return. In other words, he examines whether the lottery index value for a stock is a proxy for its proportion of retail trading. Using daily data for all NYSE retail orders during March 2004 through December 2014, for small NYSE trades of U.S. common stocks (a proxy for retail trading) during January 1993 through July 2000 and for lottery index inputs during 1940 through 2016, *he finds that:* Keep Reading

**December 19, 2019** - Momentum Investing, Technical Trading

A subscriber suggested comparing intrinsic momentum (IM), also called absolute momentum and time series momentum, to simple moving average (SMA) as alternative signals for equity market entry and exit. To investigate across a wide variety of economic and market conditions, we measure the long run performances of entry and exit signals from IMs over past intervals of one to 12 months (IM1 through IM12) and SMAs ranging from 2 to 12 months (SMA2 through SMA12). We consider two cases for IM signals and one case for SMA signals, as applied to the S&P 500 Index as a proxy for the stock market and the 3-month U.S. Treasury bill (T-bill) as a proxy for cash (the risk-free rate). The three rule types are therefore:

- IMs Case 1 – in stocks (cash) when past index return is positive (negative).
- IMs Case 2 – in stocks (cash) when average monthly past index return is above (below) average monthly T-bill yield over the same interval.
- SMAs – in stocks (cash) when the index is above (below) the SMA.

We estimate S&P 500 Index monthly total returns using monthly dividend yield calculated from Shiller data. This estimation does not affect index timing signals. We focus on net compound annual growth rate (CAGR), maximum drawdown (MaxDD) and annual Sharpe ratio as key performance metrics, with baseline stocks-cash switching frictions 0.2%. We use buying and holding the S&P 500 Index (B&H) as a benchmark. Using monthly closes of the S&P 500 Index during December 1927 through November 2019 (92 years), and contemporaneous monthly index dividend and T-bill yields, *we find that:*

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