Hi, the momo strategy is rank based, unbiased, where as TA is discretionary that point is taken.
On research the following data is found:
Research shows that combining momentum strategies with technical analysis (TA) can enhance the effectiveness of momentum trading. Studies have found that momentum strategies, which focus on buying stocks with high past returns and selling those with low past returns, can benefit from the incorporation of TA indicators such as moving averages, relative strength index (RSI), and MACD (Moving Average Convergence Divergence).
One study highlights that using technical indicators to confirm momentum signals can improve returns and reduce drawdowns. For instance, using moving averages to confirm the trend can help avoid false signals, while RSI can provide insights into overbought or oversold conditions, enhancing entry and exit timing. The combination of momentum with TA can also help manage risk by identifying potential trend reversals earlier than momentum signals alone [ā][ā].
Another research paper emphasizes that integrating TA with momentum can address some of the behavioral challenges of momentum investing, such as the tendency to hold onto losing positions for too long or selling winners too early. By providing more structured and data-driven signals, TA can help investors adhere to the strategy more consistently [ā].
In summary, merging momentum strategies with technical analysis can provide a more robust framework for momentum strategy, potentially improving performance and risk management. This combination leverages the strengths of both approaches, offering a comprehensive strategy that adapts to various market conditions.
This is an extremely informative thread! How do you judge financial health of a company? I only look at the profit and revenue growth but I feel I can go deeper if you help me with what to look for.
Thank you.
You are referring to Growth+ Momentum strategy, infact that is adding another factor to Momentum strategy itself.
Books say pure momentum strategy outperforms the diluted one.
Having said that the only thing comes to our rescue during crash or draw down is fandamental of the company and topline, EPS growths are a part of that.
So make a list of stocks as per your criteria and apply momentum strategy on those, you may not be achieving extra ordinary returns but your drawdown will be better than Pure momentum play.
After a long period of research, I have not found any discernible evidence that technical analysis significantly enhances the performance of momentum strategies. Itās important to be aware that technical analysis is of two types:
Technical Indicators: These are reasonably systematic and include RSI, moving average, exponential moving average, etc. These are tested thoroughly, and we already use basic ones like moving average, or within some percentage from an all-time high, etc. These work. I havenāt seen anything that enhances performance more, like RSI or donchain channels or similar indicators. The more indicators we add to the momentum strategy, the higher the probability of having a false positive breakout or false positive exits. Churn increases, and returns go down because you constantly enter and exit. In my backtesting, I observed that keeping the core filters like moving average and all-time high, analogous to momentum, is acceptable. Anything else derates the strategy performance
Technical Chart PatternsāThese are discretionary and almost impossible to backtest, so I donāt know how these patterns will enhance or derate the strategyās performance.
Now, to āwhether we should use technical analysis or not?ā
The answer is that āit dependsā - the traditional momentum factor in academia doesnāt have a moving average filter, nor does it go into cash. But most of us do that to enhance our strategies, and we have found that it has worked historically in our markets. Now, for technical analysis, if you have tested it or are confident that it will increase your performance and help you stick with the strategy, plus make you more comfortable, please go ahead and use it. The only thing to remember is that every technical indicator or chart pattern, or extra filter you add will have a trade-off. If you try to reduce the drawdown to a lower extent, you will lose on cagr. There is no holy grail.
While I follow my systematic strategy according to the rules I have set for myself, I also understand that to make money in markets, having multiple uncorrelated strategies is a must. This diversification ensures that you can stick to the rules and not get bogged down if one strategy is in deep drawdown during the current market regime. Itās a safety net that provides security and preparedness.
Poor quality : The strongest trends are seen in low quality stocks. This gets worse as a bull market progresses. When a momentum strategy works for long periods of time you end up allocating more of your capital to duds, and when the party ends you are unable to exit.
Operators are smarter : Operators also know about TA. I have seen a pattern in a few stocks when the stock price gets pushed down without any news just before a big upmove. Probably stop-loss and margins calls get triggered and then the stock makes a big upmove. So purely rule-based systems cant participate in such price movements.
Perpetual arms race : If all traders use the same methods, then no one makes any money. So you need an edge. The larger/smarter traders use far more sophisticated methods than discussed here.
Having said that quant methods are quicker at identifying trends than waiting for a quarterly financial result. I see it as a way of fishing out insider activity. If well informed investors are accumulating some stocks - it may show up as TA patterns like breakouts, crossovers or whatever.
@vml , Totally agree with you. Along with charts, breakouts, we need to incorporate fundamentals to avoid such traps, even if returns may sufferā¦But big drawdowns can be saved.
Well, in most cases, the very reason of getting into something like Momentum is to get away from discretion and all the issues that come with it ( bias, cost of decision making, etc ).
There are 2 levels of discretion you will need to bring back ā Technical ( Charts ) & Fundamentals ( Business )ā¦both will need time and effort so you will need a bigger alpha to compensate for the same. Also, Momentum & Fundamentals often contradict each other so youāll be in a perpetual fight with your biases and emotions.
Yes. There has been many instances where price momentum divorces with fundamentalsā¦Loss making companies keep on getting higher and higher. But no need of conflict. We can restrict ourselves to only those price momentum where fundamentals are good. Then when market start going south, arleast drawdown will be lower in good quality companies.
One very important thing I observed in momentum investing based on ranking isā¦
Top ranking companies are always faar away from bases and they are in stage 2 but in very extended moves. So there are high chances that after that big move they may retrace back or consolidate.
Rather those stocks which are lower in ranking, possibility is more that they may be breaking out of bases or near their bases and safe to invest in them for quite a long time. Its actually a contradictionā¦Has anybody observed this???
@Mudit.Kushalvardhan Yes. One way is to look for SMA crossovers (breakout) and then rank by RSI (for momentum). I just modified the SMA Crossover screener and the results are interesting
Many of you might have seen drawdown (DD) in your respective pf. Did you understand the variation in DD wrt benchmark N50, lower your market cap of the company higher is the DD, the thing which I mentioned in the previous replies, the thought process is looking for the fundamentally good companies and you may apply momentum strategy over there, it may be called as swing trading, but be it whatever the name you give it. Essentially it helps to prevent your loss. At the end market rewards to those who values fundamentals.
Thank you for your information, I urge followers to go through the articles especially of Rajan Raju, will help in long time in the investment journey.
