Momentum Algorithm: Surfing the wave

Momentum Algorithm

[financial_chart csv_filename="momentum.csv"]

Momentum Algo: What goes up… goes up?

Author: Peter

Intro

The momentum algorithm is a very well known and a well-researched algorithm. It basically says that stocks which go up for a bit have a high chance to continue, and stocks that go down for a while will continue to do so. But momentum is not enough to get a proper return. We only want momentum in quality stocks. So we filter on this as part of our automated analysis.

Independent on what a certain stock does, we also have to look at the wider market, so we look at the uptrend’s dispersion with an index and sector. Some sectors might be out of favour, and some markets might be on a glide path down. Let’s not buy those!

This algorithm always finds the gems, so if tech companies are driving the market, we surf the wave; if primary production companies are killing it, we invest in those: this algorithm aims to be very dynamic.

Hypothesis

The hypothesis of this algorithm is that movement is followed by more movement in the same direction. It’s as simple as that.

Stocks tend to maintain recent price trends in the future, and the momentum strategy uses this. It’s silly but loads of people say this should not be a positive factor… yet, it is the most robust factor we have found

Inner Workings

Every day we scan 8,000 stocks and select the best on fundamental factors.
We find the companies that profit from their core operations (we use a proprietary metric that takes the capital structure into account). They must have healthy balance sheets (not too much debt, enough cash to cover their R&D and dividend payments) and have shown that their metrics are improving over time.
Once we find them, we wait until Big Money discovers these fantastic companies, and we ride the uptrend.

The gory details

For people who want to know more:

Momentum indicator: Modified Momentum is the momentum based on the AverageTrueRange that expresses not only the momentum but also the velocity of the momentum
Quality: Take the highest “Modified Dupont ROE” (net margin*asset_turnover*equity multiplier). The Modified Dupont ROE is a proprietary indicator that determines the Health of stocks based on their Return On Equity, taking into account the company’s capital structure.
Weighting is based on the Smooth Momentum factor and the Drawdown Risk.
- The smoother the momentum, the higher the weighting. Smooth momentum is defined as the number of up days
- The higher the Drawdown Risk, the lower the weight.
Universe: stocks
- that have over the 30 day Average a daily dollar volume of USD 10m+
- Stock is not classified as in the Finance Insurance And Real Estate industry
- The company must have a Market capitalisation of at least $500M USD

Disclosure:

The Information on this page is based on backtesting and is, therefore, to be considered as HYPOTHETICAL. Any financial products described on this page will be issued by third parties, as disclosed in the relevant disclosure document. All information is general information only and does not take into account your personal circumstances, financial situation or needs. Before making a financial decision, you should read the relevant disclosure document and consider whether the product is right for you and whether you should obtain advice from a professional financial adviser. Any information contained on this page may have been automatically generated by an algorithm based on raw data inputs, has not been independently verified and is subject to change.