This blog covers the general topic of financial markets.

Antonacci's Dual Momentum (part 1/2)

first posted: 2019-11-10 04:44:11.640358

Author and Book Contribution

In 2014, Gary Antonacci published Dual Momentum Investing. This book was very influential at least in making a distinction amongst momentum strategy:

  • relative momentum, or relative strength is the strategy buying stocks that outperformed the rest of the market. It may offer an increased return, but it is at the cost of investing in more volatile stocks, and is therefore a high return, high risk strategy, this has been documented by academics since the 80s.
  • absolute momentum or trend following is the strategy of entering a trade only when a trend is present and keeping the money in safe assets otherwise. This strategy does not enhance average returns much, but it reduces volatility and drawdowns drastically, leading to a much better Sharpe ratio (risk adjusted return).

The book discusses facts relevant to investments and asset allocation and shows how strategies that dominate the market return can be built using either relative or absolute momentum. It then proceeds to combine both strategy into a "dual momentum" strategy which dominates both components.

Besides offering a simple market beating strategy. One major contribution of this book was to clarify that what academics call momentum covers two distinct strategies, and introduces different names for these to disambiguate the term.

The term relative strength and trend following have been associated with more vocal seats of the pants and non-scientific practitioners, while the more scientific ones exploited the market anomaly.

Market Wisdom

  • Preface: buy and hold exposes investors to drawdowns that are too high, investors need risk management
  • World's First Index Fund: Antonacci explains how stock-pickers are subject to transactions costs and all sorts of bias. Hence the success of passive, low cost index funds
  • In the 70s, the author saw some investors beating the market consistently. He considered enrolling for a PhD in Chicago University but felt that EMH (Efficient Market Hypothesis) was taken there as a religious truth rather than a hypothesis.
  • He created an arbitrage derivatives fund in the late 70s that was ruined by unusual events coupled with overleverage
  • In the 80s, he used Bayesian portfolio optimization to invest capital in the world's top traders such as Paul Tudor Jones, Louis Bacon, Richard Dennis, John W Henry, Al Weiss, Tom Bladwin and Jim Simmons. These traders stopped investing other's people money and invested their own capital.
  • in the 90s, as data percolated towards academia, several anomalies were reported, and the momentum anomaly was presented.

Past Trend Followers and Relative strength Investors

Antonacci gives a whirlwind tour of momentum prior art. A word of warning is order: as brokers have an interest in their customers churning their accounts, it has always been easy for so called "market specialist" to obtain a salary from brokerage to advertise their theories, whether those obtain profits or not.

The chart analysis has gained bad press from its unscientific use of pattern and use of unscientific, unfalsifiable claims. Some of the early authors quoted below applied trading as an art more than as an repeatable application of statistical techniques.

  • David Ricardo in 1838 said "cut your losses; let you profits run on" and managed to retire at 42.
  • Jesse Livermore was a famous trader quoted "stocks are never too high to begin buying or too low to begin selling". Antonacci omits the fact theat Livermore was ruined several times bailed out in murky circomstances and eventually committed suicide after a series of bad trades ruined him.
  • Richard Wyckoff wrote a 1924 book "How I trade in stocks and bonds" where he advocated buying the strongest stock in the strongest6 index.
  • George Seamans (1939) recommends relative momentum in "The seven Pillars of Stock Market Success"
  • Arnold Bernhard in the late 20s, founder of value line, advocates relative momentum combined with earning growth momentum,
  • Robert Rhea in 1932 published "The Dow Theory" inspired by H M Gartley developped momentum based ratings in the 20s
  • HM Gartley wrote in 1945 "Relative Velocity Statistics" and a 1935 book "Profits in the stock market"
  • The first scientific study of the subject comes in 1937 with Afred Cowles and Herbert E Jones here or here.
  • Chestnutt wrote a book on relative strength investing in 1961
  • William O Neil motto was "Buy the strong, sell the weak"
  • Gilbert Haller (1965) advocated strongest stock in "The Haller Theory of Stock Market Trends"
  • George Soros (2003) theory of reflexivity is viewed by the author as a form of momentum investing
  • in 1960, Donchian began trading commodities based on 5 days and 20 days moving average. His 4 week channel breakout method inspired Ed Seykota and Richard Dennis
  • Richard Dennis taught donchian chanel breakout to the turtles
  • Seykota launched "Ed's Six Step Program" to train traders. (He seems to gives behavioral rather than scientce grounded technical advise).
  • Richard Driehaus began his investment carrier in 1968, he was featured in "The new Market Wizards" and "Investment Gurus"
  • Richard Levy (1967) pioneered computerized work on "relative strength"

Relative Momentum

The seminal paper by Jegadesh and Tittman (1993) published Returns to Buying Winners and Selling Losers or here showed from a study from 1965 to 1989 that winning stock outperformed losers by 1% per month.

Since Jegadesh and Tittman, 300 papers on momentum were published, and 150 in the last 5 years. These academic papers on momentum are studying a "relative strength" effect which enhances return while causing additional transaction costs and doing nothing to reduce volatility and drawdown.

  • DWA started 4 ETF based on momentum (it would appear that only one survived) PDP
  • AQR established 3 momentum based funds AMOMX
  • Blackrock started a MSCI USA Momentum Index based ETF MTUM