Frequently Asked Questions
It seems that a lot can happen between the beginning of the month when your momentum indices adjust their positions and the beginning of the next month when new signals are given.
Research has shown that stock prices are reactive rather than trending for shorter periods of time, such as days and weeks. Stocks are more likely to rebound from short-term fluctuations than continue in the same direction. It is usually better to ignore short term movements and retain a longer term perspective.
If momentum investing is so great, why aren’t more people doing it?
It usually takes awhile for research to work its way into the investment marketplace. We saw that with indexing. Public awareness should grow as information about momentum gets better assimilated over time.
There are also other reasons why momentum investing has not caught on. First, it is not as psychologically appealing to buy what has gone up in price as it is to buy things that appear to be cheap. Second, momentum may seem too simple to those who think more complex approaches have more merit. Finally, some investors have strong prejudices against newer styles of investing or investing in indices rather than in stocks.
Interestingly, the same behavioral factors that explain why momentum works also explain why momentum has not caught on yet: anchoring, conservatism, and the slow diffusion of information.
What are the main risks associated with dual momentum investing?
One risk is that past history is driven by randomness, and the future may not be like the past. However, there are several hundred years of out-of-sample performance supporting momentum. There are also strong behavioral biases pointing to why momentum has a good chance to continue working.
There is some risk that momentum will attract substantial capital and not work as well in the future because of too many participants. But the stock indices we use are much more scalable than individual stocks.
Another risk is occasional timing miscues that cause a dual momentum portfolio to lag behind its benchmarks. Over the past 40 years, our Global Equities Momentum (GEM) model under performed its benchmark in 1979-80 and 2009-11. No strategy outperforms all the time.
There is also some risk associated with the trend-following component of dual momentum being slow moving to minimize whipsaws. This means that much of the short term volatility of the stock market still exists with dual momentum.
Additionally, there re-entry lags when a new bull market begins after dual momentum has taken you out of a prior bear market. Please see the Disclaimer page of for additional risk factors.
Should one invest using your papers’ momentum portfolios?
My papers were meant to illustrate the principles of momentum investing and not as models for actual investing. Historically, the highest risk premium has come from equities. There are some who would have you believe based on shorter amounts of data that a more diversified approach is better. But long-term research shows that momentum works best when applied to geographically diversified stock indices.
My book’s GEM model is designed as a do-it-yourself approach using dual momentum focused on stock indices. The section called “How to Use It” in Chapter 8 of my book shows how you can easily implement the GEM model.
How many sectors does your Dual Momentum Sector Rotation (DMSR) model invest in at any one time?
The number of sectors depends on one’s attitude toward reward and risk. Fewer sectors mean higher expected returns and higher volatility. You can use the principles in my book to develop a sector rotation model that suits your own risk preferences. However, I show here the performance of DMSR using additional data since my book was published. DMSR is no longer as attractive as broader-based dual momentum models like GEM. I no longer use sector rotation, nor do I encourage others to use it. Academic research shows that momentum gives the best results with geographically diversified stock indices.
What about adding small cap stocks, REITs, gold, commodities, or the NASDAQ100 to GEM?
None of these add value to GEM. As with sectors, their volatility and drawdown are very high. Dual momentum does best with moderate volatility. When volatility is too high, you give up significant profits before you can enter or exit positions.
Why don’t you use the U.S. Total Stock Market index instead of the S&P 500?
Results have been a little better with large cap stocks. This is mostly because there is no real small cap premium. See our blog posts for more on this.
Why do you update the performance of only the Environmental, Social, and Governance and Global Equities Momentum models on your website?
My ESGM and GEM models are publicly disclosed. Anyone who reads my book can easily implement them. My other dual momentum models like Global Balanced Momentum and Enhanced Global Equities Momentum are proprietary. I license them to several investment professionals who use them to manage customer accounts.
I like your Global Balanced Momentum (GBM) model because it holds both stocks and bonds. What don’t you report its performance? What can I do along those lines?
Bonds behave differently than stocks. So my GBM model has different parameters than GEM. It also holds a different portfolio from what was in my book. GBM is one of the proprietary models I license to investment professionals. To achieve a similar risk profile, you can use the suggestion at the end of chapter 8 of my book and allocate a permanent percentage of your portfolio to short-term bonds and the remainder to GEM.
My 401k plan does not include an all country world stock fund. What can I use instead?
Most 401k plans include a fund for non-U.S. developed market stocks. You could use that instead. If your 401k has an emerging markets fund, you could create a synthetic ex-U.S. all country world fund by allocating 20% to the emerging markets fund and 80% to a non-U.S. developed markets fund. Your signals could still be derived from an ex-U.S. all country world stock fund.
What about adding value, quality, low volatility, or momentum stock indices to GEM?
They do not improve our results. Even if they did, I would be suspicious of them for two reasons. First, most funds using these are subject to data mining and selection bias in their construction. Second, real time results from factor-based investing has been disappointing due to price impact and other real-world influences. This may get worse in the days ahead as the amount of capital in factor funds continues to increase. See our blog post “Factor Zoo or Unicorn Ranch?”
Are there any outside validations of your GEM model?
There are a number of them. One is at TrendXplorer. You can also do your own back testing with ETFs or mutual funds at Portfolio Visualizer. You should use an S&P 500 fund to determine “single absolute momentum.”
Have you looked at whether there is a best time of the month to reevaluate and rebalance your portfolios? What about trading part of the portfolio each week instead of all of it once a month?
Studies show that stocks perform best early in the month. This is when institutional investors make changes to their portfolios, and prices are most representative of their true value. Rebalancing during that time frame has the best results with our models.
GEM has had some close signals for switching in and out of stocks. What would you do then?
All our published results are based on month-end closing prices. I have tested using a 50/50 allocation to stocks and bonds when the signal is close. Results are about the same. To reduce feelings of regret no matter what happens, you may want to use this approach. Another possibility is to wait a few days and see which way the signal goes.
It looks like the GEM model under performed the S&P 500 for a couple years after 2009. Has momentum lost its effectiveness?
Dual momentum has a trend following component that lags behind when a new bull market begins.That is the cost of avoiding the carnage of the preceding bear market. It is unfair to look only at a new bull market without also considering the preceding bear market.You need to consider a full market cycle at least to make a proper evaluation of performance. GEM has outperformed its benchmark portfolio since 2008 and earlier.
You also need to understand why GEM has outperformed over the long run. First, are its profits from switching between U.S. and non-U.S. stocks according to relative momentum. Since 2009, U.S. stocks have continuously outperformed non-U.S. stocks, so there have been no opportunities for relative strength profits. Secondly, the current bull market has been one of the longest in history, so there have also been no opportunities for absolute momentum profits. It is difficult for any trend following approach to keep up with the stock market when it is abnormally strong.
You should focus on process rather than performance. You could say that GEM has lost its effectiveness only if you believe U.S. stocks will always outperform non-U.S. stocks or that there will never be another bear market. Finally, if GEM underperforms over shorter periods of time, many investors are willing to accept that because of the drawdown protection it has shown during prior bear markets.
Since there is no ETF for dual momentum investing, how tax efficient is it?
GEM is relatively tax-efficient. Since 1971, 73% of its gains have been long-term while nearly 100% of its losses have been short-term. Those losses can offset some of the long-term gains.
What any investors don’t realize is that over 40% of the long-run return of the S&P 500 has come from dividends. These are taxed at ordinary income rates whether or not they are earned in an ETF. What investors should really pay attention to is the expected return they end up with after taxes, as well as the drawdowns they will experience along the way.
Stock valuations look high now, and bond yields are low. Will this adversely affect dual momentum returns?
High stock valuation levels can mean lower expected stock returns, and low bond yields usually point to lower future bond returns. But stocks and bonds still fluctuate and create opportunities. In 2000, there were also high stock market valuations and low bond yields. But our GEM model had a compound annual return of 11.6% over the next 10 years. A 60/40 stock/bond portfolio returned only 2.3%.
The stock market is up a lot this past year. Is there a lot of risk if I get started now?
The stock market is subject to V-shaped, panic-induced bottoms, but tops are a different matter. It usually takes time for them to form as bulls and bears battle for dominance. By the time this happens, absolute momentum can catch up with prices so that stock market exits are not that far away from market tops. You can see that by looking at the GEM chart on the Performance page of this website.
Will dual momentum will lose its effectiveness when more people are using it?
An anomaly can certainly lose profitability if it starts being widely followed. However, the behavioral basis behind momentum is strong and persistent. Human nature does not readily change. So I expect the causation factors behind momentum to continue.
It is unlikely that most people will become dual momentum believers. Many have been brought up as value or buy-and-hold investors. Their biases may keep them from ever adopting dual momentum. This is especially true of institutional investors who often have a strong aversion to any kind of tactical allocation. Even if this were not the case, Shleifer and Vishny (1997) show that asset managers are afraid of strategies that deviate from their benchmarks because investors may leave following periods of under performance.
In aggregate, the performance of actively managed funds is inferior to passively managed funds. People have known about that for many years. Yet over 70% of all domestic equity funds are still actively managed. Dual momentum investing may very well show the same disconnect.
How do you determine the best look back periods for your models? Won’t shorter look back periods get you in and out of the market sooner?
Academic research shows that over the long run, momentum for stocks works well with a look back period of 3 to 12 months. Longer look back periods minimize transaction costs and increase the likelihood of long-term capital gains.
While shorter look backs may get you out of and back into markets sooner, they can produce more whipsaw losses. This can actually lead to lower returns and larger drawdowns. A 12-month look back period was found to work well by Cowles & Jones in 1937. It has held up remarkably well ever since and is commonly used in academic research. Staying with this look back period reduces concerns about data mining and seasonality bias.
Some investors skip the last month when applying momentum. Why don’t you do that?
It makes sense to skip the last month when you are applying momentum to stocks because individual stocks can overreact to news and then mean revert. If you want to use momentum with stocks, see this blog post or our review of the book Quantitative Momentum. If you use stock indices or other asset classes like we do, you do not need to skip the last month.
Why does the performance of the GEM model begin in 1974 in your book and 1971 on your website? Why not look at even more data?
When my book was written, the earliest bond index data I could find was from 1973. Now I have additional bond index data, so the GEM performance record on my website goes back to January 1971. It is constrained now by the lack of data for on-U.S. stock indices. I go back to 1927 when looking at U.S. equities with absolute momentum where international stock index data is not needed. See my blog posts, Absolute Momentum Revisited and And the Winner Is. Both relative strength and absolute momentum have been individually tested back to 1801. See Geczy and Samonov (2015).
When I back tested GEM, there were a few months in which I see GEM is in foreign stocks, but you show GEM in aggregate bonds. Why is that?
On page 101 and 112 of my book I give a simplified logic for GEM so anyone can easily implement it using a free charting website. There is a minor difference if you calculate the signals as discussed on page 98 of my book. I mention there that I determine absolute momentum using only the S&P 500 index, since the U.S. leads world equity markets. I cite a supporting reference. This means we may occasionally be in aggregate bonds if the trend in U.S. stocks is down even when non-U.S. stocks are the strongest asset.
Isn’t value investing the opposite of momentum investing? How can both be valid?
Value and momentum operate on different time frames. Value is based on long-term mean reversion, while momentum relies on intermediate (usually 3 to 12 months) serial correlation. Despite all the attention it has received, there is evidence now that value investing has not held up well in the real world. See my factor investing blog post.
Why do you use absolute momentum for trend following instead of a moving average?
With moving averages, you compare an asset’s current price to an average of prices over the look back period. With absolute momentum, you compare the current price to the price at the beginning of the look back period. This means moving averages signals are more sensitive. They give more than 25% more trades than absolute momentum over the same look back periods. Absolute momentum has fewer false signals and whipsaw losses, as well as lower transaction costs.
Zakamulin shows that absolute momentum outperforms 3 different types of moving averages on 155 years of stock market index data. Absolute momentum is one of only two methods that outperform the market with statistical significance.
What about using stop-losses with dual momentum?
Stop-losses were once thought to reduce return when they reduced risk exposure. Recent research shows that stops can actually enhance returns if they are used with care. I have a blog post that discusses this. Dual momentum is more effective than stop losses in reducing risk exposure and enhancing returns. Stops are usually redundant and unnecessary when using dual momentum.
Since momentum works best geographically, why not use it with country index ETFs?
Dual momentum works best when volatility is not too high. Individual countries can have extreme volatility. This can make it difficult to get in and out using trend following momentum without giving up a lot of profit. This is the same reason we do not use small cap indices or stock sectors. Additionally, country index funds often have lower liquidity and higher trading costs than broader- based index funds. This can create the same serious price impact and scalability issues as momentum applied to individual stocks.
How do leveraged ETFs perform with dual momentum?
There are drawbacks to using leveraged ETFs. First, most leveraged ETFs use daily resets which are best suited for day trading. There can be large tracking errors when holding leveraged ETFs on a longer term basis. Daily resets are also not tax efficient since leveraged ETFs will give mostly short term capital gains or loses. Finally, leveraged ETFs have a leverage factor of 2X or greater. This may be too much leverage. There is still considerable short-term volatility with dual momentum. This may cause discomfort with 2X or greater leverage.
Have you looked at using inverse equity instead of bond ETFs when absolute momentum
tells you to exit stocks?
Equities are the core of our models because they have shown the highest long-run risk premium. Shorting stocks is therefore climbing an uphill battle. We want every advantage we can get by having the highest risk premium on our side to serve as a tailwind for future performance.
There are also higher costs associated with inverse ETFs. You can own an S&P 500 ETF for an annual expense of 4 basis points, while the expense ratio of an S&P 500 inverse ETF can be 89 basis points.
Because stocks have an upside bias and our models are slow moving, there is often not much profit from short positions by the time you enter and exit. The average bull market since 1942 has lasted 32 months, while the average bear market has lasted only 12 months. Switching to bonds during stock market weakness as identified by dual momentum has historically done better than being short stock indices.
There are international stock ETFs that hedge their currency exposure. What about using these with GEM?
There is a tendency for international stocks to outperform U.S. stocks when the U.S. dollar is weak and non-U.S. currencies are strong. This lets us profit from the strength in non-U.S. currencies. When non-U.S. currencies are weak, GEM is usually out of international stocks. There is little reason to use hedged ETFs. GEM automatically deals with exchange rate exposure.
What is the best way for non-U.S. Based investors to use dual momentum?
We have a blog post called “Dual Momentum for Non-U.S. Investors” that discusses this in detail. What I would add to it now is non-U.S. investors may want to use their home country bonds in their portfolio. Those who cannot use an aggregate non-US stock index fund can construct an equivalent by using a mixture of developed and emerging market funds.
Do you make your buy and sell decisions using month-end prices?
Consistent with most academic work, my models’ entries and exits are based on monthly closing prices that reflect total returns. If you want to trade the same day as your signals instead of waiting until the next day’s open, you can set up a portfolio on SharpCharts that updates real-time during trading hours and get your signals just before the markets close.
What are momentum crashes, and do I need to worry about them?
These are caused by the short side of long/short momentum suffering large losses when stocks rebound sharply off V-shaped market bottoms. This happened in 1932 and 2009. Since we do not hold short positions, momentum crashes are irrelevant to us.
How do you invest your own funds?
I developed dual momentum specifically for my personal investing. Nearly all my liquid net worth is invested using proprietary dual momentum models. I license most of these to investment advisors for managing their customer accounts.
How are your proprietary models different from the GEM model disclosed in your book?
Like GEM, my proprietary models are simple and robust. But they are more adaptive to market conditions. They also include more ETF choices. My more conservative proprietary models apply dual momentum to fixed income as well as equity markets.
Can dual momentum be used with markets other than stocks and bonds?
Both absolute and relative momentum have worked well with different asset classes for more than 200 years. But stocks have historically given the best returns. Bonds generally do well when stocks are weak, which is when we hold them. Receiving a lower annual return because of permanent diversification into assets like bonds means you could end up with only half the amount of assets over a lifetime of investing.
With bonds being in a bull market over the past 35 years, does the use of aggregate bonds with Global Equities Momentum (GEM) overstate future expected performance?
Aggregate bonds have an average duration of around 5 years. This means they are not as sensitive to interest rate changes as longer duration bonds. As the following chart shows, their returns have been relatively stable and steady.
GEM and ESGM have been out of equities only about 30% of the time. Aggregate bonds have been responsible for only 20% of our models’ profits.
Absolute momentum is used to exit equities and enter bonds when it first identifies a bear market in stocks. These usually precede recessions, which often lead to falling interest rates as aggregate demand lessens. When stocks are weak, there is also a tendency for investors to move from stocks to bonds. This also increases demand for bonds.
Our models aim to only be in bonds during bear markets in equities. You can see below how intermediate bonds have performed during those times.
It seems reasonable to accept a little duration risk during bear markets in stocks. If you disagree, you can substitute shorter term bonds or Treasury bills for aggregate bonds with only a small fall off in performance.
© 2018 Portfolio Management Consultants All Rights Reserved