Using Momentum to Navigate Financial Markets: Insights from Quantca Financial

Summary: In this episode of Quantca Financial’s Concept Education Series, the concept of momentum is explored. The CEO discusses the two common categories of momentum – cross-sectional momentum and time series momentum, with a focus on the latter. The episode includes a demonstration of time series momentum using the TradingView platform and shares a model created by Quantca Financial for educational purposes. Overall, the episode provides valuable insights into the concept of momentum in financial trading.

Time Series Momentum Trading

Detailed Synopsis: Time-series momentum refers to the correlation between a market’s performance and its continued success over a specific period of time. Certain assets exhibit consistent momentum behavior, while others do not. Time series momentum is a concept used by Quantca Financial that involves analyzing the momentum or trend of a particular asset over a specific time period. In this episode, the speaker discusses the basics of time series momentum and its application in trading.

The episode begins by introducing the topic of momentum and regression, two concepts that work well together. The speaker mentions that Quantca Financial is unique in its willingness to share information and code related to these concepts. They emphasize that the model being discussed is for educational purposes only and is not a recommended trading model.

The speaker then explains that there are two common categories of momentum: cross-sectional momentum and time series momentum. For this discussion, they focus on time series momentum, which they describe as a basic concept that can be easily demonstrated using the TradingView platform.

To illustrate time series momentum, the speaker uses the example of the S&P 500 ETF SPY on a daily timeframe. They mention that they have created a custom indicator called “momentum percent true” using an algorithm. This algorithm calculates the percentage of time that the returns of a specific time window are positive, and then correlates this with the returns of the next time window. The resulting visualization shows the correlation increasing as the time period extends to around 60 days.

The speaker acknowledges that determining the significant period of time for momentum analysis can be subjective, but for this demonstration, they focus on a historical correlation of 60 days. They then present the backtest results for trading the S&P 500 based on increasing momentum. The strategy is shown to be profitable while maintaining a smaller drawdown than buy-and-hold during significant market downturns, such as the 2008 financial crisis and the COVID crash.

The speaker addresses the question of why this strategy, which captures periods of market growth, does not always beat a simple buy and hold strategy. They explain that while it may not outperform buy and hold in terms of overall returns, there are other benefits to consider. For example, this strategy allows investors to avoid significant drawdowns during market downturns, which can be advantageous for risk management. The speaker discusses three use cases for momentum:

  • The first use case is when an investor wants to hold a bundle of assets, such as the S&P 500, but wants to avoid the drawdowns of longer term market downturns and have a more stable portfolio. Momentum can be used to help mitigate the impact of market downturns and provide a more even keel portfolio.
  • A second use case is combining a momentum strategy that only trades in trending markets, with a successful strategy that trades during volatile market conditions to generate alpha.
  • The third use case is where an investor can use momentum to keep their porfolio within a volatility threshold, and add leverage. By adding leverage to a momentum strategy, the investor can potentially exceed the market returns while still maintaining a lower drawdown than the underlying market itself. It is important to note that we do not use leverage at Quantca with the exception of certain accredited investor services.

In conclusion, time series momentum trading strategy involves analyzing the momentum of an asset over a specific time period to determine when to enter or exit trades. While it may not always outperform a buy and hold strategy in terms of overall returns, it can help investors avoid significant drawdowns during market downturns. This strategy can be useful for risk management and may be combined with other trading strategies for a more comprehensive approach.

 

Leverage

To demonstrate the potential benefits of momentum, the speaker compares the returns and drawdowns of an unleveraged S&P 500 ETF to a two times leveraged S&P 500 ETF (SSO). Leveraged ETFs are exchange-traded funds that aim to provide a multiple of the daily returns of an underlying index or asset. These funds use derivatives and other financial instruments to amplify the returns of the underlying asset. The unleveraged strategy had a return of 123% with a low drawdown over a specific time period that included the 2008 financial crisis and the COVID crash. In comparison, the leveraged strategy had a return of 368% with a drawdown that was still lower than the unleveraged S&P500 over the same time period. This shows that using momentum plus leverage can significantly enhance returns, even during periods of market volatility. It is important to note that leverage comes with increased risk and should be used with caution. The speaker mentions that leverage was not used in accounts managed by Quantca Financial, except for accredited investors. This highlights the need for proper risk management and understanding of the potential risks involved when using leveraged ETFs.

 

This is part 1 of a 2 part series. For more information, see our episode on Regressions.

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Looking for our white paper analyzing mean reversion and momentum? Send us your email here to get exclusive access to our FREE Investment Analysis Whitepaper.

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Your whitepaper is on the way! Register for a free account HERE for access to exclusive members-only videos and analyses.