Momentum Investing: Trendrating’s Model

By: Siyanda Pali

First published: 17 July 2015

Momentum, as defined in the 2014 paper Fact, Fiction and Momentum Investing, is the phenomenon which states that securities which have performed well relative to peers on average continue to outperform, and securities which have performed relatively poorly tend to continue to underperform.



It is important to further qualify this definition. The term ‘relative’ is an important one. Momentum is sometimes confused with trend following. Despite being related, these terms are not similar. Trend following usually focuses on absolute price changes, while momentum involves ranking securities relative to their peers. Trends increase exposure during upswings and decrease exposure during downswings. 

Momentum, on the other hand, takes no explicit view on the market trend, but simply ranks securities relative to each other over the same time period, which may lead to an implicit net directional market view. ‘Winners’ and ‘Losers’ based on momentum are defined regardless of how the market is performing overall. During the 2008 global financial crisis for example, a winner would have been down only a few percentage points relative to stocks that on average were down more than 30%. During upswings, losers would be similarly defined as stocks that were up a few percentage points compared to those with more significant gains.

This is directly opposed with the view by De Bondt and Thaler (1985) who show that over a 3 to 5 year holding period, shares that performed poorly over the previous 3 to 5 years achieve higher returns than stocks that performed well over the same period. However, the interpretation of these results is still being debated.

As highlighted by Geczy and Samonov (2013), evidence of momentum in US stocks can be seen for some 212 years (1801-2012) in what the above champion, with an understandable degree of pride, as “the world’s longest back test.” The academic discovery of momentum however, as cited by Jegadeesh and Titman (1993), has only been over a 20 year period.

Analytics provider Trendrating specializes in providing tools and techniques to assist Investment Managers and Advisors measure the momentum factor as part of their investment strategy.

John Coulter, Managing Director in North America for Swiss-based Trendrating states in an article by Caruthers (2013) that, “What we are doing is trying to determine the strength and duration of momentum to predict a trend developing so an Investment Manager can participate in the trend earlier and capture more profits.”

Coulter concedes that Trendrating’s model has been live for 2 years, but was developed and tested over 5 years. He also explains that they created their model by thoroughly analyzing 350 technical indicators, which were then whittled down to 8. The weighting of the 8 indicators is adjusted monthly and Coulter further states that the model has exhibited a 77% to 80% accuracy at identifying a greater than 10% price move which lasts a number of months to years.

Asness, Frazzini, Israel and Moskowitz (2014), authors of the aforementioned paper published in the Journal of Portfolio Management, are all proponents of the strategy and assert that the strategy offers impressive long-term average returns.

For obvious reasons, Coulter won’t reveal indicators used in Trendrating’s model. However, he affirms that the model can be of aid to investors by both identifying and exiting trends quickly. The model used by Trendrating provides a rating system of grades ‘A’ to ‘D’, with ‘A’ representing a strong bull trend and ‘D’ a strong bear trend.

As highlighted by Caruthers (2013), Coulter reveals that in June and July 2014, the model saw several oil and gas stocks change from ‘A’ and ‘B’ ratings to a ‘C’ rating, the market proceeded to go into freefall in September and October.

Coulter states that they give investors a way to look at movement- strength of prices within a specific country, market, index, sector and culminating in a stock.

The company targets customers ranging from Fund Managers to ETF Managers and offers 8 different modules of its analytics platform for different types of investors. Trendrating also has a Strategy Builder module for Mutual Funds which has the ability to model a portfolio around momentum securities.

References

1. Asness C, Frazzini A, Israel R, Moskowitz T (2014), Fact, Fiction and Momentum Investing, Journal of Portfolio Management. [Online] Available from: http://dorseywrightmm.com/sites/default/files/SSRN-id2435323.pdf [Accessed: 8 July 2015]
2. Caruthers ( 28 April 2015) Fierce Finance, Niche Financial Models Provider Focuses on Momentum Investing, [Online] Available from: http://www.fiercefinanceit.com/story/niche-financial-models-provider-focuses-momentum-investing/2015-04-28
3. De Bondt and Thaler (1985) Does the Stock Market Overreact? The Journal of Finance. [Online] Available from: http://www.jstor.org/stable/2327804?seq=1#page_scan_tab_contents [Accessed: 10 July 2015]
4. Geczy and Samanov (2013) 212 Years of Price Momentum (The World’s Longest Backtest 1801-2012) Wharton University of Pennsylvania, Finance Department [Online] Available from: https://fnce.wharton.upenn.edu/profile/924/research [Accessed: 10 July 2015]
5. Jegadeesh and Titman (1993) Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency, The Journal of Finance. [Online] Available from: http://www.e-m-h.org/JeTi93.pdf. [Accessed: 10 July 2015]