Saturday, May 19, 2012

The Epic Momentum Bubble v.2

Yesterday, I backtested a simplistic momentum strategy. It once worked. It no longer works.

Today, I offer a more complex strategy.

Here are the new rules.

1. If the S&P 500 was up yesterday and the day before yesterday, then it will be up today too. Go long!
2. If the S&P 500 was down yesterday and the day before yesterday, then it will be down today too. Short it!
3. Otherwise, do nothing.

Start with $1 invested in 1957. Here are the results.

Click to enlarge.

It's not nearly as impressive as the strategy I used yesterday but it did still turn $1 into $147 in just 43.3 years. That's a 12.2% average annual growth rate. Too bad it all fell apart in 2000.

I once again offer you one of the more amusing losing streaks. Watch as the strategy gets whipsawed.

2003-03-27 868.52
2003-03-28 863.50
2003-03-31 848.18
2003-04-01 858.48 Short! Lost 1.2%!
2003-04-02 880.90
2003-04-03 876.45 Long! Lost 0.5%!
2003-04-04 878.85
2003-04-07 879.93
2003-04-08 878.29 Long! Lost 0.2%!
2003-04-09 865.99
2003-04-10 871.58 Short! Lost 0.6%!
2003-04-11 868.30
2003-04-14 885.23
2003-04-15 890.81
2003-04-16 879.91 Long! Lost 1.2%!
2003-04-17 893.58
2003-04-21 892.01
2003-04-22 911.37
2003-04-23 919.02
2003-04-24 911.43 Long! Lost 0.8%!
2003-04-25 898.81
2003-04-28 914.84 Short! Lost 1.8%!
2003-04-29 917.84
2003-04-30 916.92 Long! Lost 0.1%!
2003-05-01 916.30
2003-05-02 930.08 Short! Lost 1.5%!
2003-05-05 926.55
2003-05-06 934.39
2003-05-07 929.62
2003-05-08 920.27
2003-05-09 933.41 Short! Lost 1.4%!
2003-05-12 945.11
2003-05-13 942.30 Long! Lost 0.3%!
2003-05-14 939.28
2003-05-15 946.67 Short! Lost 0.8%!

Ouch. Let's zoom to see the how the strategy has done since 2000.

Click to enlarge.

Note the flat line in recent years (as was also seen in yesterday's strategy). For all intents and purposes, this strategy is now dead.

It took me, a human, at most a few moments to think up these two momentum strategies. High frequency trading algorithms can data mine 24 hours a day each and every day looking for patterns. In my opinion, the little guy doesn't stand a chance. Day traders beware!

Source Data:
St. Louis Fed: S&P 500


Stagflationary Mark said...

As a side note, yesterday's strategy turned $1 into $38,000 in 43.3 years.

That's a 27.6% average annual return. It ended with an epic exponential trend failure. Game over.

Mr Slippery said...

Your thesis seems to be that HFT trading has squeezed all profit out of momentum trading.

What I find interesting is, why would it flatline right after the 2008 crash?

Is that just coincidental timing to the crash and the perfection and proliferation of nanosecond WOPRs?

Most bonds are not traded like stocks, but PIMCO last year set up an ETF for their main bond fund, so maybe bonds are due for the HFT squeeze soon enough.

Stagflationary Mark said...

Mr Slippery,

Is that just coincidental timing to the crash and the perfection and proliferation of nanosecond WOPRs?

I think it could be. I guess this would be my thesis.

From 1957 to 2000, traders could make money betting with the momentum herd.

From 2000 to 2009, traders could make money betting against the momentum herd.

From 2009 to present, traders are having a harder time making any money. Old simplistic momentum strategies no longer work. The little guy with "free trading tools" provided by a broker to encourage him to trade more is therefore at an extreme disadvantage.

The lowest lying fruit is gone. There is increasing competition for the little fruit that remains.

This theory fits in well with my central theme. It is becoming increasingly difficult to make money off of money (as also seen in TIPS and I-Bond yields).

Mr Slippery said...

You can still make good money as an insider with info from the other side of the Chinese wall, selling inflation IPO offerings to the muppets, borrowing from the Fed at 0.25% and buying treasuries with a higher yield.

But using above board methods and without being a primary dealer (or his wife), it's rough out there.

Mr Slippery said...

Oops, strike inflation from inflation IPO.

Stagflationary Mark said...

Mr Slippery,

I'm going to have nightmares tonight based on what you typed.

I'm picturing Ben Bernanke ringing the opening bell on Wall Street surrounded by the other members of the Federal Reserve. They are all smiling.

The headline in the Wall Street Journal:

Inflation goes public. Up 50% on the opening trading day!

Today's IPO was a success! Investors flocked to the Consumer Price Index story (Ticker: CPI).

Let's not go there, lol.