In this article, we will discuss
- What is the Dual Momentum Trading Strategy?
- Types of Dual Momentum
- What is the Formula for the Dual Momentum Investing Strategy?
- How Dual Momentum Investing Strategy Formula Work?
- What are the Strategies for Implementing the Dual Momentum Trading Strategy?
- Dual Momentum Investing – Real Life Examples
- What are the ways of Identifying Dual Momentum Signals?
Everyone knows that the secret to a successful trade is entering and exiting your positions at the right time. However, it is also true, quoting Warren Buffet, that “Trying to time the market is the number one mistake to avoid,” for it is almost impossible to detect the correct trend.
So, what can traders do to spot the right trend? The answer is simple. Follow the dual momentum trading strategy.
What is the Dual Momentum Trading Strategy?
Dual momentum trading strategy is a technique which helps you determine which security to buy and when to enter a position by using two types of momentum. It draws a comparison between two or more assets and helps you select one with the highest momentum, along with comparing it with its past performance.
By following this strategy, traders can book short-term gains and avoid long-term losses by rotating their investments across various sectors. Furthermore, they can use this tactic across several asset classes like stocks, index funds and bonds.
This trading strategy was first mentioned in “Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk”, a book written by investment expert Gary Antonacci . To help you gain a better understanding, let’s move on to the meaning of momentum and its types.
Types of Dual Momentum
Momentum signifies the rate of change in an asset’s price over a particular time period. It is usually represented in the form of a percentage and can be checked from the momentum oscillators of your preferred trading platform.
It can be classified into two types:
Absolute momentum measures the performance of an asset based on its own historical data. In simpler terms, it is the change in a security’s price over a specific time period represented in percentage.
In case the asset has a positive price change, it is called positive momentum. Additionally, greater the rate of price change, higher the absolute momentum and vice versa.
Relative momentum is a measurement of a security’s performance with that of its peers over a specific time period. This means that it contrasts the absolute momentum of one asset with others to determine which has outperformed the rest. It can help traders detect securities which are likely to keep performing well given their recent performance.
What is the Formula for the Dual Momentum Investing Strategy?
The formula for dual momentum trading is as follows:
Momentum Score = (Absolute Momentum * Weight) + (Relative Momentum * (1 – Weight))
Absolute Momentum - Current Asset Price / N-period Past Price
Weight – A digit between 0 and 1, which helps determine the return rate for traders to invest considering absolute vs relative momentum.
Relative Momentum - Asset Return / Category Return
How Dual Momentum Investing Strategy Formula Work?
The dual momentum trading strategy uses the above-mentioned formula to calculate a momentum score for each security. It takes into account both the absolute and relative momentum of an asset over a specific time period. Its goal is to select securities which have historically outperformed its peers, along with their own performance in terms of positive momentum.
This formula also takes into account the bill rate. It is the interest rate applicable on short-term government bonds, and its inclusion helps traders make informed choices as per the current market scenario.
Securities which have higher momentum scores and positive momentum returns are termed as strong performers. During a bull market, investors should consider buying and holding on to such assets in order to increase their profitability.
Inversely, assets with low momentum scores and returns are termed weak performers. Individuals should avoid and sell such securities when the market is entering a bearish phase.
What are the Strategies for Implementing the Dual Momentum Trading Strategy?
Following are some of the most popular dual momentum trading strategies:
Modular Dual Momentum Approach
This dual momentum strategy entails that investors should compare two parts of a sector or two similar sectors and determine which has performed better over the last 12 months. Now, if the better-performing one has positive absolute momentum, they should invest in it. However, in case it has negative absolute momentum, they should hold investment grade and treasury bonds.
Here are some modules, according to Gary Antonacci, to which one can apply this strategy:
1. REITS (Mortgage REITS – Credit REITS)
2. Equities (US stocks – International stocks)
3. Economic stress (Gold – Treasury bonds)
4. Bonds (Credit bonds – High-yield bonds)
Dual Momentum Sector Rotation
In this approach, investors need to choose various exchange-traded funds (ETFs) which represent different asset classes, sectors and regions. Then, they need to rank them according to their returns over the last 12 months and buy the three top-ranking ones.
However, their absolute momentum should also be positive. By doing so, they can periodically shift to better-performing sectors, thus reducing the chances of long-term losses.
Dual Momentum Investing – Real Life Examples
Let’s take a look at some examples to understand how the dual momentum investing strategy works in real life:
Futures Contracts of Natural Gas and Crude Oil
Suppose you are monitoring natural gas and crude oil futures. Now, over the last two months, you notice both assets having a downward (negative) momentum. Natural gas had a price decline of 20%, while crude oil fell by 15%.
In this regard, you can say that natural gas has an absolute momentum of 80% whereas crude oil has an absolute momentum of 85%. Thus, natural gas has a higher negative absolute momentum and negative relative momentum than crude oil at the moment.
As per the dual momentum strategy, the asset with higher downward momentum is more likely to continue declining. Therefore, under such circumstances, the best course of action will be to short the natural gas futures.
Gold and S&P 500 Index
Your analysis over the last 12 months shows that gold had a 20% price rise while the S&P index increased by 15% in value. In this regard, you can say that gold has an absolute momentum of 120% while the S&P 500 has an absolute momentum of 115%.
Hence, as gold has a higher positive absolute momentum and positive relative momentum, it is more likely to continue increasing in the time to come. Thus, given the current scenario, you must invest in gold.
What are the ways of Identifying Dual Momentum Signals?
Well, there are no hard and fast rules to identifying dual momentum signals. You simply need to follow the main concept of buying the strongest among the high-performing assets and selling the weakest among the low-performing ones.
In a nutshell, the dual momentum trading strategy can be very effective when it comes to increasing profitability by choosing the right assets. However, to successfully implement this tactic, you will need access to a trading platform which can help actively track market data.
In this regard, the New-Gen Samco app is all you need. It has integrated features to help you track several aspects of your target assets like price, ask/bid quotes, market volume, etc., along with alerts for major changes in the stock market.
So, what are you waiting for?
Download the Samco app today and make informed decisions regarding your investments!
Frequently Asked Questions
Q1 .How to implement the dual momentum trading strategy?
Ans. You can implement the dual momentum trading strategy by selecting the assets you want to compare, determining their signal periods (time period for analysing price change), calculating the dual momentum signals, buying or selling assets as per your findings and rebalancing your portfolio depending upon your signal period.
Q2. What are the advantages of dual momentum investing?
Ans. Some of the benefits of using a dual momentum trading strategy are easy implementation, minimum time requirement and help avoid heavy losses during market downturns.
Q3. What are the risks associated with the dual momentum investment strategy?
Ans. The dual momentum investment strategy requires frequent trading, leading to higher transaction expenses. Furthermore, it may not be an effective approach during times of volatility.
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