Tag: momentum

Simple Momentum with Transaction costs and Taxes

The earlier post on a simple momentum strategy ignored transaction costs and taxes. Typically, these are added to backtests where gross profits are high enough to consider them for further analysis. However, one of readers requested that we add these costs to get an idea of their effect on returns.

To keep things simple, we assumed a 25bps net transaction cost and a 10% tax on gains. The tax part is a bit tricky so we ran the analysis with some simplifying assumptions. Follow the github link to the code if you are curious.

Running with these assumptions, transaction costs and taxes lopped 82% off gross returns over Jan 2005 through June 2018.

cumulative midcap 100 simple momentum strategy returns after transaction costs and taxes

What kills you are the taxes, not the transaction costs. There were only 17 trades throughout the period. It is the 10% tax on gains that ruins the compounding.

Code and other charts are on github. Look for ones with a ‘tx’ in the suffix.

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Simple Momentum

Michael Batnick, in his blog titled “Simple Momentum,” proposes a strategy that follows a simple rule:

If the S&P 500 outperformed 5-year U.S. treasury notes over the previous twelve months, invest 100% of this portfolio in the S&P 500 in the following month. If the 5-year U.S. treasury notes outperformed the S&P 500 over the previous twelve months, invest 100% of this portfolio in bonds in the following month.

It outperformed the S&P 500 with significantly lower drawdowns. Could the same strategy work with Indian indices? We took NIFTY 50 and MIDCAP 100 indices and paired it with the 5-10 year tenure gilts.

Returns

The strategy returns are significantly lower than a simple buy and hold. December 2004 through June 2018, the NIFTY 50 version of it under performed buy and hold by 6% and the MIDCAP 100 version by 34%. This is before transaction costs and taxes. Here are the cumulative return charts:

NIFTY 50 simple momentum

MIDCAP 100 simple momentum

Drawdowns

The simple momentum strategy did have lower peak drawdowns than a buy and hold:

NIFTY 50 simple momentum drawdowns

MIDCAP 100 simple momentum drawdowns

What keeps you out of the troughs also ends up keeping you out of the peaks. This is highlighted by how the strategy behaved in 2008 and 2009:

NIFTY 50 simple momentum annual returns

Conclusion

The simple momentum strategy is perhaps too simple. The backtest doesn’t capture transaction costs and taxes that would further ding the already lagging gross returns.

You can peruse the code and the charts used in this blog on github.

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Relative Momentum Back-test

Daily data of over 35,000 global indexes published by NASDAQ OMX including Global Equity, Fixed Income, Dividend, Green, Nordic, etc. are available for free download on Quandl. Out of which about 1000 indices are USD denominated Total Return (TR) indices. We were curious to find out the result of applying our Relative Momentum algorithm on this subset. We also wanted to know if the rank of the Indian TR Index within this subset can be used to time NIFTY or MIDCAP investments. To know more, download the pdf Relative Momentum Back-test.

The charts in the document are low-res. Whatsapp us on +918026650232 for the high-res ones.

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Trend Following vs. Trend Prediction, Part II

We are finally past the 100-day milestone on our machine-learning trend-following models. Here is how it compares against our other momentum models:

The ML algos out-performed a majority of traditional momentum algorithms. “NN” here stand for Neural Network and “ML” for models that use a SVM under the hood. It will be interesting to see how these models look under the 200-day lens as the short-term “luck-factor” evens out.

You can check out these models here.
The first post in this series is here.

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Benchmarking against a Momentum Index

When we first launched our momentum strategy in India back in 2013, we were one of the few to openly talk about momentum as a systematic strategy. Even the thematic indices that were later launched by the NSE focused on value and beta. This resulted in momentum strategies being forced to inappropriately benchmark against market-cap weighted indices. Thankfully, that is not the case anymore.

S&P BSE Momentum Index

The BSE came out with a Momentum Index last year which can now be used to benchmark momentum strategies. An obvious flaw in this index is that it is rebalanced only once in 6 months whereas most academic research on momentum assume a monthly rebalance. However, if you look past that, it is a better alternative.

Here is how our Momo Relative Momentum strategy compares against the index:

Our risk-managed momentum strategy has out-performed the momentum index even after transaction costs.

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