Momentum Strategy

This article aims to analyse whether it is possible to take advantages from momentum. From Investopedia:

“ The idea of momentum in securities is that their price is more likely to keep moving in the same direction than to change directions. In technical analysis, momentum is considered an oscillator and is used to help identify trend lines ” .

In this article I would like to illustrate the back-test of a Long/Short strategy which exploits momentum. This is a 6-months rolling strategy which consists in taking a Long position on the 20 best performers of the S&P500 and a Short position on the Index. Therefore, it is a Delta Neutral strategy which aims to take advantage from momentum, without assuming a directional view on the stock market.

Particularly, I back-tested this strategy using real stock market data and considering the period from 10.October.2005 to 13.October.2015. Before pointing out the results, I would like to explain how I run the back-test. As I mentioned above, it is a 6-months rolling strategy; therefore, for each semester of the 10 year period considered, I identified the 20 best performers of the S&P and I invested in those stocks for the following 6 months.

In addition, for the entire investment period, I maintained a short position on the S&P500, creating in this way a Delta Neutral strategy. It is important to notice the Long position is changed every semester, according to the S&P 500 top 20 performers of the previous 6 months.

The following graphs show the semi annual performance of the Top 20 Basket, the S&P 500 and the Momentum Strategy:

In addition, in the following table, it is possible to notice some statistics which point out the value added by the Momentum strategy:

As you can see from the chart above, the Momentum strategy has provided the best Sharpe Ratio in the last 10 years, with a maximum drawdown very low compared to the S&P 500.

Furthermore, it is possible to look at the following graph in order to compare the historical performance of the Momentum Strategy with the Top 20 Basket and with the S&P500.

Source: Bloomberg as of 10/11/2015

It is interesting to notice that the Momentum Strategy provides a good protection against period of market turmoil. For example, during the 2008 Global Financial Crisis, the Moment Strategy has outperformed significantly the S&P500 (+17.93%).

To conclude, it is important to take into account that I am not considering implicit cost of trading like the fees that partially modify the return of the Momentum strategy. By the way, I used this simplification because of the lack of information and, in any case, the result would not be changed a lot.

Tommaso Calegari

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