The momentum in the tactical allocation of assets – genxfxtrader
What it is meant by momentum? The concept is very simple. As in physics, an object tends to remain in motion until it involved an external force, also in the world of investing an asset that has worked well tends to keep doing it for a certain period of time, while one that worked evil tends to continue malfunctioning.
Therefore, the momentum can be defined as the persistence of performance.
Over 20 years of research convincingly confirm the validity of momentum. In the latter period, momentum strategies are experiencing a period of great popularity. In 2017, the momentum recorded the best performance among the factors equity or factors .
The most commonly accepted explanation for the existence of momentum derived from behavioral finance that link the momentum itself to the way the market assimilates information.
In the short term, investors tend to be slow to metabolize new information. For the theory of efficient markets, new information is immediately incorporated into prices. Indeed, in a first phase, involving some behavioral biases that tend to slow down this process.
At first, it tends to “anchor” expectations to previous price levels (Anchor) and sell their own winners too soon, slowing climbing or delay selling their losers to avoid losses, slowing his fall. (Effect of disposal). All this has the effect of slowing the start of the trend.
In a second phase, however, everyone wants to jump on the winning car, convinced that the recent trend will continue forever (recent trend and representativeness bias).
Therefore a lack of initial reaction is followed by a further subsequent overreaction which tends to extend the persistence of the trend. Once the trend is consolidated, managers are particularly interested in placing assets performed better in their portfolios to show to manage your customers who have mounted successful to the winning horses.
In the context of momentum strategies, the time interval considered is of fundamental importance.
Overall, it has been observed that investments have performed well over the last 3-12 months ( training period ) tend to do so in the next 1 to 12 months ( maintenance period ).
In very long or very short periods, however, there are phenomena return to the average (mean reversion) of asset prices. Therefore, the momentum does not deny the existence of a reversion to the mean of the market, but simply notes that yields tend to be autocorrelated in certain periods of time.
Sometimes momentum strategies, including the training period and the waiting period, a brief interval is inserted to allow prices naturally return to trend after an increase. For example the period 12-1 can be used as training period 12 months to one month, in these cases, before the observation.
There are two types of momentum: It
is very important to note that the roles these two types of momentum play within a portfolio strategy are not the same. Both can increase performance but only the absolute momentum significantly reduces the significant risks and drawdown of the portfolio. The absolute momentum works better than bonds by reducing the correlation with the stock market and reduces the need to diversify asset classes that have a low expected return.
The best results (especially strategies long only ) are obtained with a combination of the two . In this case, the relative time allows an improvement in performance, while the absolute time avoids negative scenarios out of the market once it has identified a downward trend.
Among the metrics used to measure the strength of the trend, the most widely used is the yield past.
However, sometimes you can use other measures. Among these, non – exhaustively, we can mention the difference between the price and the moving average of n periods, the difference between average short and long term, the slope of the average percentile in which the price is compared to the range in the training period, the difference in terms of standard deviations from the mean.
Let ‘s try one momentum tactical asset allocation in 6 asset classes represented by the same number of ETF sold in the US market strategy.
VTI – US overall stock market
EFA – Developed ex US equity market and Canada
VWO – Emerging markets stocks
IEF – Treasuries 7/10 anni
RFL – Investment Grade Corporate Bonds
GLD – Gold
apply a strategy relative time ( relative strength) That, on monthly basis, select the top 3 assets based on performance over the past 10 months. Assets thus selected are matched within the portfolio.
We compared the relative time strategy with the simple strategy of “buy & hold” (buy and hold) and equitable portfolio of 6 kinds of initial assets. As we can see, compared to the “buy & hold” a portfolio of 100% shares, not only the risk is reduced through greater diversification, but also increases performance .
Compared to an equivalent portfolio of the 6 classes of assets, the relative momentum allows a significant increase in performance and a slight decrease in volatility. The Sharpe ratio goes from 0.6 to 0.89.
To further reduce the risk of the portfolio, we added a strategy of absolute momentum. As in the previous case, we select the top 3 assets on a monthly basis depending on their relative performance. Then apply an additional filter in terms of trend (or absolute time) investing in selected assets only if the price is above the moving average corresponding to 10 months. If the selected price of one or more assets is below the moving average, the funds will be moved to cash.
As we can see, adding momentum strategy allows a greater absolute reduction in the risk of the portfolio, the drawdown and the correlation with the stock market. In this case, it also decreases the performance of the portfolio, but Sharpe ratio increases to 0.91.
These and many others are strategies that can allow to optimize the efficiency of a portfolio management incorporating more dynamic although this does not invalidate the efficiency actually has of itself a portfolio well diversified indexed .