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Momentum Strategy

Copyright: Pillious

The short version:

Research has shown that there is a greater statistical likelihood that markets or equities that have increased or decreased most within the past six months to the past twelve months, will continue to rise or fall within the next 6 to 12 months, respectively.

If you buy a broad portfolio of such momentum shares, you are more likely to beat the market index, over time. Momentum is an academically well-researched and recognized method that has been proven to have yielded higher returns in history across both countries and asset classes.

On this background, it may make sense to implement a simple investment strategy aimed at buying the stocks that have risen the most and selling the stocks that have fallen the most, as this trend will continue. The result is a higher return than if you would have just invested in the equity market index. The explanations for the success of this factor must be found in human behavior. Classical finance theory often rests on the assumption that we humans are rational individuals, but in practice this is often far from the truth as human psychology and behavior play a huge role.

This is about going into stocks with enough volume and lots of liquidity, so that you can always exit at the desired average price – so that you do not affect the price in a positive or negative direction. It is important to assess the technical analysis: Has the stock shown that the bottoms have increased or are we now moving in a declining trend? If the stock has performed better than the market for two years, it is attractive to do the technical as well as the fundamental analysis.

We complement the momentum strategy with a currency approach. In simplified terms, the currency factor tends to have securities that are cheap in terms of financial ratios (currency shares) over time have outperformed shares that are expensive in terms of financial ratios (growth shares).

Currency shares have historically outperformed overpriced growth stocks, and they have also typically outperformed investments in a broad equity index – such as the Danish C25 stock index.

Momentum is the investment factor we use in Pillious for long-term equities. Here we calculate the momentum for and select our investments, among others, the shares of the US leading index Dow30.

We are also in the Danish, German and Nordic markets, where we trade equities from the Danish OMX C25 index as well as the most liquid large and midcap equities, but we also invest in US equities from Nasdaq, S & P500 they weigh most of our portfolios since the liquidity and volume is greater. We have used momentum to select Danish and US stocks since 2014, and as shown in the graphs and key ratios on this page, we have achieved significantly better returns than the market returns annually because we trade on the fluctuations.

 

Value:

Value shares are stocks that are currently traded at a price lower than their actual internal price. This basically means that the shares are undervalued, ie. traded at a price lower than their true value, making them an attractive investment opportunity for investors. We are doing what we call an ESG screening of the stock. We assess the profitability of the company before investing, ie. we go through all of their key figures.

What are we looking at?

Investment Metrics:

The three popular investment metrics used to estimate the intrinsic value of a stock are the P / E ratio, the P / B ratio and EPS (Earnings Per Share).

Price-to-earnings (P / E) ratio:

The price / earnings (P / E) ratio is the most widely used investment metric in the investment world.

Price / earnings ratio = Share price / total earnings

The P / E metric is the most popular one, because it creates a relationship between a stock price and a company’s overall earnings, which gives a clear indication of whether it is an undervalued stock or not.

Price-to-book (P / B) ratio

Another popular investment metric is the price to book ratio (P / B). The P / B metric creates a relationship between the price of the stock and its book value. It is also a very effective way to determine if a stock is undervalued or overvalued.

Price-to-book ratio = Stock price / book value

An companies book value is determined by subtracting its total liabilities from its total assets.

Results per share (EPS)

Earnings per share is another popular investment metric used to determine a stock’s intrinsic value. It is calculated as follows:

Earnings per Share = (Net Income – Preferred dividend) / Average common shares

Momentum:

If you use relative momentum, you buy the shares that at the time of purchase showed the relatively best price development compared to other shares. This is because research has shown that there is a greater statistical likelihood that markets or stocks that have risen or declined most within the past half to full year will continue to rise or fall within the next half to full year.

Risk-adjusted momentum:

In Pillious, we adjust in our momentum calculations for the standard deviation to obtain more stable returns over traditional momentum. The strategy in Pillious is therefore to continuously adjust the portfolio to include the shares of the S & P500, Nasdaq and Dow Jones that have shown the most momentum over a long period. However, it must be said that we also go in and assess the fluctuations in the last 5 days that are at the best momentum from a risk-adjusted point of view.

Risk adjustment:

A very widespread method for this is the use of the so-called Sharpe Ratio (hereafter abbreviated S). This Sharpe Fraction was developed and introduced by Nobel laureate William F. Sharpe in the mid-sixties. Investing with the highest S ratio gives the greatest (risk-adjusted) return. Sharpes Ratio is given by:

Where µ is the expected annual return as a percentage and r is the reference rate (most often the interest rate on a short bond) S.D. is the standard deviation of the return S thus expresses the expected excess return relative to a reference rate that an investor can expect per standard deviation. Or, put another way; how well you can expect to be paid to take on additional investment risk.

Buy and keep the winners

The continuous adjustment mentioned above takes place at regular intervals of approx. 2 weeks, where the contents of the portfolio are decided on the basis of the risk-adjusted momentum of the shares. The risk-adjusted momentum can also be called a 1-10 momentum score. The momentum score is the value of the calculations of the individual share’s risk-adjusted momentum, ranked from highest to lowest. If it does not maintain its momentum as expected it is out and a new one is taken in as we have screened. There is a waiting list on all the shares.

When deciding on the content of our portfolios, among the stocks with the highest momentum score, buy (or increase) should be at 8,9 or 10. While selling out completely or reducing the shares that are no longer at the top. In this way, it is ensured that the portfolio with reallocations contains those shares that have the highest momentum score at the time of reallocation.

 

RSI as a momentum indicator

RSI is also used as a momentum indicator. The idea is that bigger price movements indicate, the investor mass is moving. Then it is important to hang on and join the movements that have started, with even more investors coming later and drives the stock price in the same direction.

 

Remember the risk distribution

Do not put all your eggs in one basket. This also applies to equity investments.

Thus, risk diversification always makes sense when investing – even when it comes to strategy level. For example, if a man uses both value and momentum strategies in his portfolio at the same time, one can open both excess returns and prospects in the portfolio value, as the strategies are relatively uncorrelated and often change to give a great return. The higher return stability makes it easier to be an investor.

 

Strategy level diversification

As stated above, it makes good sense to spread your investments between different strategies, both LongTerm and DayTrading but also some swing trading. Dividend stocks are not a bad idea in the long term, but these stocks shouldn’t be traded on a daily basis, only invested for a longterm and hold strategy. Here Pillious moment can be a strategy diversification element in a portfolio where one wish to get better returns and a more consistent portfolio value. When spreading your investment on multiple sectors, countries and strategies there will be a greater likelihood of not losing as much in case of a potential loss.

What is momentum?

Momentum – also known as the momentum factor – is academically recognized, which is a very compelling strategy we use for long-term equities.

Academic research documents, which are more statistically probable, current as a rise or fall within a short period, eg the latest half to the whole year, are added with the considered consideration respectively to increase or fall over the coming period. Against this background, it may make sense through implementation and simple investment strategies based on shares that have risen most and sell the ones that have fallen the most, as this trend will continue. The result is a higher return than if, alternatively, only the equity market index as a whole was invested. The risk may vary over time, but over a long horizon, it is seen to be on a level, and through a momentum strategy in the long term receive a higher return per. risk unit.

The explanations for the success of this factor must be found in human behavior. Classical finance theory often rests on the assumption that we humans are rational individuals, but in practice this is often far from the truth as human psychology and behavior play a big role.

This is about going into stocks with enough volume and lots of liquidity so that you can always exit at the desired price point, so that you do not affect the rate in a positive or negative direction. It is important to assess the technical analysis, the stock has shown that the bottoms have been increased or are we now moving in a declining trend. If the stock has performed better than the market for 2 years, it is attractive to do the technical as well as the fundamental analysis.

Investing via momentum has, in theory and practice, among other things in Pillious, produced higher returns than market returns across both geographical regions and asset classes.

HOW WE HAVE BEATED THE STOCK MARKET

Factor investment – academic well documented

Investing on the basis of momentum is, in line with value investing, an academically well-documented investment strategy that is advantageous to have in your portfolio.

Investing on the basis of value or momentum is also known as factor investing, where stocks are selected with certain favorable characteristics (factors) that have over time rewarded a disciplined and long-term investor.

Value: Buy shares that are cheap based on key figures

In simplified terms, the valuation factor tends to have securities, for example equities that are cheap in terms of financial ratios (exchange rates), over time have outperformed equities that are expensive in terms of financial ratios (growth equities).

Valuation shares have historically outperformed overpriced growth stocks, and they have also typically outperformed investments in a broad equity index, such as the Danish C25 stock index, which is equivalent to investing in all 25 stocks in the stock index. As a value investor, you only buy those of the 25 shares that are cheap measured on key ratios.

Momentum: Buy the best performing shares

Simply put, momentum is a proven trend that the shares that have had the most rising price trend over the past half to full year will also yield better returns over the next half to full year than the shares that have had the least rising price trend .

Therefore, the momentum strategy is to buy or hold good performing shares, and sell or avoid buying poor performing shares. In addition to our good results with the momentum strategy in Pillious, it has been demonstrated by academics that a significant additional return over time – a so-called premium – can be achieved by investing in this way.

In the academic research, the momentum effect has been documented across countries, regions, sectors and asset classes. It has even been observed over very long periods of time and has therefore been sustained over time.

Additionally referred to long back in history

Momentum is an academically well-researched and recognized investment factor that has been proven to have yielded far-reaching returns in history across both countries and asset classes. We have gathered some of the academic research here.

A widespread misunderstanding

Many people believe that momentum strategies perform worse than other investment strategies in falling equity markets. It may appear at times, but our research and actual results at Pillious show that this is not always true. For example, our return on European and Danish equities outperformed the world market. However, there is a risk associated with this but runs down when the market falls, as it is not short positions but longer ones.

One of the reasons for our better performance is that, in Pillious, we use risk-adjusted momentum calculations and sub-portfolios to reduce the return on our funds and create better long-term returns for our co-investors.

Combine value and moments

As an investor, it is sensible and advantageous to diversify its funds at both the securities and asset class levels, but this can / should also be done at the strategy level. For example, it is well-documented that momentum-based and currency-based investment strategies complement each other well because they are low correlated.

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EXAMPLES OF oTHER ACADEMIC MOMENTUM FACTOR RESEARCH

•         Asness et. al (2014): Fact, Fiction and Momentum Investing

•         Asness et. al (2012): Value and momentum everywhere

•         Geczy & Samonov (2017): Two Centuries of Multi-Asset Momentum (Equities, Bonds, Currencies, Commodities, Sectors and Stocks)

•         Griffin et. al. (2003, revideret i 2015): Momentum Investing and Business Cycle Risk: Evidence from Pole to Pole

•         Hurst, et. al (2014, revideret i 2017): A Century of Evidence on Trend-Following Investing

•         Jegadeesh & Titman (1993): Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency