Tuesday, July 16, 2013

Momentum Crash and Recovery

In my book I devoted considerable attention to the phenomenon of "Momentum Crashes" that professor Kent Daniel discovered. This refers to the fact that momentum strategies generally work very poorly in the immediate aftermath of a financial crisis. This phenomenon apparently spans many asset classes, and has been around since the Great Depression.  Sometimes it lasted multiple decades, and at other times these strategies recovered during the lifetime of a momentum trader. So how have momentum strategies fared after the 2008 financial crisis, and have they recovered?

First, let's look at the Diversified Trends Indicator (formerly the S&P DTI index), which is a fairly generic trend-following strategy applied to futures.  Here are the index values since inception (click to enlarge):

and here are the values for 2013:

After suffering relentless decline since 2009, it has finally shown positive returns YTD!

Now look at a momentum strategy on the soybean futures (ZS) that I have been working on. Here are the cumulative returns from 2009 to 2011 June:

and here the cumulative returns since then:

The difference is stark!

Despite evidences that indeed momentum strategies have enjoyed a general recovery, we must play the part of skeptical financial scientists and look for alternative theories. If any reader can tell us an alternative, plausible explanation why ZS should start to display trending behavior since July 2011, but not before, please post that in the comment area. The prize for the best explanation: I will disclose in private more details about this strategy to that reader. (To claim the prize, please include the last 4 digit of your phone number in the post for identification purpose.)

Upcoming events:
  1. I will be teaching an online workshop on Momentum Strategies from July 30 - August 1. Registration info can be found here.
  2. My friend Dr. Haksun Li is offering a Certificate in Quantitative Investment series of courses.