Dual momentum investing download
Diversification We like the concept of combining a fixed asset allocation with a tactical component a lot. This scheme makes sure that the portfolio stays stable and well-diversified under all market conditions and avoids potentially harmful concentration risks. The Monte-Carlo simulation shows the benefits of this diversification.
Therefore, investors should always contemplate the strategy's performance over the entire economic cycle. The rolling returns confirm that the Dual Momentum portfolio is generally lagging its benchmark while doing a great job of avoiding the downturn.
However, because of its monthly rebalancing schedule and its months horizon for momentum, the mechanism is too slow to follow fast-paced changes in market conditions. Consequently, the strategy provided only little benefits in late or spring and missed out on quick market rebounds. The tracking chart shows how the Dual Momentum has gained nicely over its benchmark until but has continuously trailed its benchmark since. You can read more about all the best investment strategies we tested here: Quant-Investing best investment strategies.
We found relative momentum works The type of momentum we found that works is called relative momentum. Buying the most undervalued companies with the best relative momentum gives you market beating returns but it does not help you to reduce volatility large up or down share price movements or large falls in share prices.
What is absolute momentum? Momentum, however, also works well on an absolute basis and it helps you reduce large losses. If the stock price return minus the return of a short term government bond, called excess return, is greater than zero, then the company has positive absolute momentum.
It is like being on a train, then hopping on to a faster one that comes along. If the train you are on starts going backwards and there are no other trains moving in the right direction, you step off on to the platform. It is possible for a stock price to have positive relative momentum if it is strong relative to other companies and negative absolute momentum if its own trend has been down.
Similarly, it can also have positive absolute momentum if its trend has been positive higher than short term bonds but negative relative momentum if another companies have gone up more. Absolute momentum been neglected In the book Gary makes an important point that researchers have thoroughly looked at relative momentum but that they have ignored absolute momentum until recently.
And this in spite of the fact that absolute momentum often provides better results and has more flexibility than relative momentum. Moskowitz, Yao Hua Ooi and Lasse Heje Pedersen which showed that absolute momentum profits were very consistent across 58 different asset classes and markets. In other words they looked at the return of 58 asset commodity and bond futures, equity indices and currencies over the past 12 months and if the return was greater than that of the US treasury bill rate they invested in the asset went long and if the return was negative they sold the asset short went short.
They found that absolute momentum profits were positive for every one of the 58 assets they examined and that returns were largest when stock market returns were the most extreme both up and down , which means absolute momentum can function as a hedge against extreme events. Why use dual momentum? In the book Gary says the best approach to investing is for you to use absolute and relative momentum together so that you use the advantages of both.
What look back period to use? As the majority of academic literature covering both relative and absolute momentum agrees that a month look-back period gives the best performance Gary also suggests that you also use a month look-back period and apply it to both types of momentum.
How to use dual momentum To do this you first use relative momentum to select the best-performing asset over the preceding 12 months. You then apply absolute momentum as a trend-following filter by calculating if the excess return the return of the asses minus the US Treasury bill return of the selected asset has been positive or negative over the preceding year. If it is positive, it means its trend is up, and you invest in the asset.
In this way you always invest with the trend of the market. Look at your investments monthly Each month you use exactly the same test to determine if you should stay invested. If the prior month excess return is negative, you sell the asset and invest in a short term bond fund.
How well does dual momentum perform? Gary tested this dual momentum strategy over a 39 year period from October to October This is what he did. He then looked to see if the selected index has done better than U. Treasury bills. If it has, he invested in the index.
PROFITABLE HEDGING TECHNIQUES IN FOREX TRADING
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