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Mitigating Impact of Price Turning Points on Trend Following

| | Posted in: Momentum Investing, Technical Trading

Is there a way to mitigate adverse impact of price trajectory turning points (trend changes) on performance of intrinsic (absolute or time series) momentum strategies? In their May 2020 paper entitled "Breaking Bad Trends", Ashish Garg, Christian Goulding, Campbell Harvey and Michele Mazzoleni measure impact of turning points on time series momentum strategy performance across asset classes. They define a turning point as a month for which slow (12-month or longer lookback) and fast (3-month or shorter lookback) momentum signals disagree on whether to buy or sell. They test a dynamic strategy to mitigate trend change impact based on turning points defined by disagreement between 12-month (slow) and 2-month (fast) momentum signals. Specifically, their dynamic strategy each month:

  1. For each asset, measures slow and fast momentum as averages of monthly excess returns over respective lookback intervals.
  2. Specifies the trend condition for each asset as: (1) Bull (slow and fast signals both non-negative); (2) Correction (slow non-negative and fast negative); Bear (slow and fast both negative); and, Rebound (slow negative and fast non-negative). For Bull and Bear (Correction and Rebound) conditions, next-month return is the same (opposite in sign) for slow and fast signals.
  3. After trend changes (Corrections and Rebounds separately), empirically determines with at least 48 months of historical data optimal weights for combinations of positions based on slow and fast signals.

They compare performance of this dynamic strategy with several conventional (static) time series momentum strategies, with each competing strategy retrospectively normalized to 10% test-period volatility. They test strategies on 55 futures, forwards and swaps series spanning four asset classes, with returns based on holding the nearest contract and rolling to the next at expiration. Using monthly returns for futures, forwards and swaps for 12 equity indexes, 10 bond indexes, 24 commodities and 9 currency pairs as available during January 1971 through December 2019, they find that:

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