Stocks on the Move - Beating the

Market with Hedge Fund

Momentum Strategies
Andreas F. Clenow

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Created by Ooi ban juan Last synced August 3, 2016

Preface

If you really want to buy the index, buy a passive ETF.

15

May 8, 2016

Theres a large amount of highly dangerous and deceptive 15

structured derivatives out there, marketed as regular old
ETFs. Before you trade an ETF, look into what it really is.
Never trust the name of an ETF.

May 8, 2016
Avoid any sort of enhanced ETF. Avoid any short ETF. 15
Actually, avoid any ETF that doesnt explicitly track a
specified index

May 8, 2016

When we have a bull market, most stocks go up but good 20

stocks go up much more. Most stocks have a quite high
correlation to the overall equity index during bull markets
and even if youve got a large portfolio of stocks, youll be
highly dependent on the overall market.

May 9, 2016

This destroys the very idea behind diversification. 21

May 9, 2016

What youre now holding is essentially varying amounts o 21

beta.

May 9, 2016

The more stocks you hold, the closer your strategy will 21
resemble the index.

May 9, 2016
Taking beta risk deliberately doesnt have to be a bad 21
thing. But you do have to be aware of it, and make sure
that you dont hold beta when the market is turning sour.

May 9, 2016

When a stock leaves the index, its usually because it had 22

poor price performance and dropped below the market ca
requirement. This makes the S&P 500 Index, and most
other indexes, momentum strategies to some degree.

May 9, 2016

May 9, 2016 23

Generally speaking, large caps tend to have lower volatilit 31

than small caps. They also tend to have less potential than
small caps. It certainly doesnt mean that its a bad idea to
trade large caps. Its just a difference that you should be
aware of.

May 9, 2016

Classic trend following is done on futures. The normal way 34

to execute this strategy is to follow trends on a large set of
futures markets, covering all major asset classes.
Professional trend followers trade commodities, interest
rates, currencies and of course equity indexes

May 9, 2016

When trading multiple assets with low or negative 35

May 9, 2016

correlation, you can achieve higher return at lower risk. 35

May 9, 2016

The most important thing to understand about trend 35

following is just how reliant it is on diversification. It
cannot be stressed enough that for trend following to work
reliably, you need a diverse set of markets to trade

May 9, 2016

The real killer is correlations. Stocks are very homogenous 37

as a group. They have a very high internal correlation

May 9, 2016

bull market almost all of them will go up. In a bear market 37

almost all of them will go down. Diversification doesnt
help you very much.
May 9, 2016

Given the high correlations and the overwhelming beta 37

component to stocks, its unrealistic to expect that your
returns will not be highly dependent on the index

May 9, 2016

Trading the short side is difficult in all asset classes, but 39

most of all in stocks.

May 9, 2016

A crucial point to keep in mind is that the momentum effe 58

will in reality work very different in a bear market.

May 9, 2016

When were experiencing bull markets or just regular old 58

boring market conditions, the momentum effect works fin
Thats because in normal and good market climates, stocks
can move fairly independently from each other.

May 9, 2016

bear market 58
May 9, 2016

usually something that drives the market declines and tha 58

will be the deciding factor for more or less all stocks

May 9, 2016

The momentum effect isnt very helpful in these kinds of 58

markets.

May 9, 2016

Dont buy stocks in a bear market. 61

May 9, 2016

the one indicator thats more important than all the others 61
is the index.

May 9, 2016

Momentum stocks tend to do very well in sideways 61

markets, as long as theres not overly much volatility.

May 9, 2016
When the overall market index 61

May 9, 2016

is heading down, almost all stocks follow it. 61

May 9, 2016

Ill declare the market to be bearish if the S&P 500 Index is 62

below its 200 day moving average. Thats a very long term
filter.

May 9, 2016

We dont sell just because the index moved down below th 63

moving average

May 9, 2016

we dont allow any new positions when the index is below 63

its long term moving average

May 9, 2016

Dont buy stocks in a bear market 63

May 9, 2016
We want stocks that not only show significant gains over 65
time, but move as smoothly as possible.

May 9, 2016

We need to take both the momentum and the volatility int 65

account.

May 9, 2016

Exponential Regression for Ranking 66

May 9, 2016

Stocks 66

May 9, 2016

While the linear regression slope is expressed in currency 67

units, the exponential slope is expressed in percent.

May 10, 2016

were looking for a medium term momentum ranking. The 69

regression calculations are all done using the past 90
trading days.

May 10, 2016

When the line in the lower pane is above zero, the stock is 69
heading up, else its heading down.

May 10, 2016

The stock with the highest slope will be on top of the list. 70
The stronger something is moving up, the higher up the
list. This is a pure momentum ranking.

May 10, 2016

We dont want to pick a stock that just had a massive 70

jump. We want to get stocks that had as smooth ride as
possible. Preferably we want to get stocks that continue in
a very smooth ascent after we buy them too.

May 10, 2016

fit 70

May 10, 2016

measure how well our price data fits the regression line. 70
Its called coefficient of determination, usually designated
2 .

May 10, 2016

If were calculating a regression slope based on price data 71

thats moving up in an almost perfect line, we can expect t
get an R 2 reading of near 1.

May 10, 2016

Zero is the minimum value for the R 2 while one is the 71

maximum.

May 10, 2016

annualized slope of the stock 71

May 10, 2016

fits 71

May 10, 2016

multiply 71

May 10, 2016

What this means is that we measure the pure momentum, 71
in the regression slope, and then we punish it for volatility
The higher the volatility, the worse the punishment.

May 10, 2016

May 10, 2016 74

May 10, 2016 75

. The next column is the ATR reading, in this case based on 75

a 20 day period

July 7, 2016

First, a stock must be trading above its 100 day moving 76

average to be considered a buy candidate.

May 10, 2016

. In normal markets, any stock near the top part of the 76

momentum ranking will be trading far above its 100 day
moving average

May 10, 2016

Second, gaps make me nervous. If there has been any mov 76

larger than 15% in the past 90 days, the stock is also
disqualified.

May 10, 2016

Annualized 90 day exponential regression, multiplied by 76

coefficient of determination.

May 10, 2016

Only consider stocks that are above the 100 day moving 76
average

May 10, 2016

Disqualify any stock that has a move larger than 15% in 76

the past 90 days.

May 10, 2016

The idea is to buy smaller positions of volatile stocks, so 79

that each stock has an equal theoretical ability to impact
the bottom line of the portfolio.
May 10, 2016

ATR in this equation stands for Average True Range 80

May 10, 2016

The true range is just the maximum of the days high to low 80
or move from previous day

May 10, 2016

The ATR therefore is just an average of these figures for a 80

number of days back

May 10, 2016

20 days 81

May 10, 2016

Risk factor is an arbitrary number that sets a target daily 81

impact for the stock. If you set this number to 0.001, then
youre targeting a daily impact on the portfolio of 0.1%, or
10 basis points.

May 10, 2016

Rebalancing is about how you change your position size 83
over time

May 10, 2016

While there are different variations of this concept, well 83

use the ATR based formula presented earlier since it does
the job well and is very easy to implement without
expensive risk tools.

May 10, 2016

For longer term investment strategies such as equity 85

momentum portfolios, a bi-weekly or monthly frequency i
good enough.

May 11, 2016

To reduce trading volume, you could set a filter as to how 85

large difference between target risk and current risk there
has to be for a rebalance action to occur.

May 11, 2016

There are no stop losses here. 86

May 11, 2016

We could however say that when we perform the portfolio 87
rebalance, each stock in the portfolio must be in the top
20% of the stocks in the S&P 500, or whatever your
investment universe is, for it to remain in the portfolio

May 11, 2016

Lets kick our stocks out of the portfolio if they are no 88

longer in the top 20% of the stocks in our investment
universe, or if its trading below its 100 day moving
average.

May 11, 2016

This is a key part of this entire strategy. If the index drops 88

below its trend filter, we dont replace stocks when they ar
sold. We dont sell just because the index went bearish, bu
we dont buy new stocks either. This will result in a slow
and orderly scale out of positions.

May 11, 2016

If the index level is all green, we check the top list again. 88
Make a new table of the top momentum stocks, using the
adjusted slope concept shown in chapter . Pick the top
stocks from the list. Buy the highest ranked stocks in the
list that we dont already own, until youre out of cash.

May 11, 2016

The portfolio rebalancing should be done more often than 88
the position rebalancing. You could for instance do the
portfolio rebalancing every week, looking for stocks to sell
and replace, and then only to the position size rebalancing
once or twice per month.

May 11, 2016

chapter 89

Extremely important

August 3, 2016

May 11, 2016 89

The Exact Trading Rules 89

May 11, 2016

Trade only on Wednesdays. 90

May 11, 2016

To reduce both workload and trading frequency, well only 90

check for trade signals once per week

May 11, 2016

We just dont trade unless its a Wednesday. 90

May 11, 2016

Rank all stocks based on volatility adjusted momentum. 90

May 11, 2016

annualized exponential regression slope 90

May 11, 2016

90 days 90

May 11, 2016

multiply it with the coefficient of determination (R 2 ) for 90

the same period.

May 11, 2016

if a stock is trading below its 100 day moving average or 90
has a recent gap in excess of 15%, its disqualified.

May 11, 2016

Calculate position sizes, based on 10 basis points. 90

May 11, 2016

AccountValue * 0.001 / ATR 20 90

May 11, 2016

Check index filter. 90

May 11, 2016

only allowed to open new positions if the S&P 500 Index is 90

above its 200 day moving average. If its below, no new
buys are allowed.

May 11, 2016

Construct the initial portfolio. 90

May 11, 2016

If the first stock is not disqualified by being below its 100 90
day moving average or having a 15%+ gap, then buy it and
move to the next. Buy from the top until you run out of
cash.

May 11, 2016

Rebalance portfolio every Wednesday. 90

May 11, 2016

If a stock is no longer in the top 20% of the S&P 500 stocks, 91

May 11, 2016

trading below its 100 day moving average 91

May 11, 2016

gap over 15% 91

May 11, 2016

left the index 91

May 11, 2016

sell it. 91

May 11, 2016

Only buy if the index is in a positive trend 91

May 11, 2016

Buy from the top of the ranking list 91

May 11, 2016

its in the top 20%, has positive trend and doesnt have a 91
large gap.

May 11, 2016

Rebalance positions every second Wednesday. 91

May 11, 2016

May 11, 2016 96