Reduce The Noise In Your Momentum Trading

For those new to momentum based investing, it’s the basic mechanics for trend following. There are many ways to deploy momentum based on your specific time frame. The most common momentum factor is using relative strength over a 6-12 month period over a specific benchmark. The idea would be to allocate to the strongest relative strength names within an index and rebalance the portfolio and sell the weakest names. Longer periods will provide the greatest momentum however they will also be subject to larger drawdowns during momentum crashes.

Relative Strength can also be calculated by using a weighted approach over specific moving averages. For example, you can use a 50 day moving average and 200-day moving average and calculate the percentage above and below the blend between these two time periods for a score.

While relative strength is a very solid momentum factor and has a lot of empirical data to back up its historical returns as a strategy, it cannot provide an edge because every investor is basically using the same factor tilt.

The biggest issue with momentum is it generates a lot of noise. This often results to investors not being able to capture the greatest returns. What ChartLabPro attempts to do is diversity way from commonly followed indicators that are not robust and generate too much momentum volatility. These models create robust confirmation of trend strength and trend exhaustion.
 

Example of Reduction in Momentum Volatility

An example of this would be the recent move in Walt Disney Co DIS and Apple Inc AAPL seen below. Below is a chart of Disney. You can also see a video on how to apply our rating and counter trend for DIS here.

The first line is the price series of the stock. The two lines below the price is our rating value model (measuring trend strength) and our counter trend model (measuring trend exhaustion). You will notice how robust the models are in their ability to remove daily price volatility; they are smooth and steady. This helps investors maximize their return on capital and gain a greater level of conviction to remain in the trade or investment. Once the rating value reaches its maximum trend strength, investors will want to focus on the counter trend. The counter trend will help investors to determine when the trend is fully exhausted and to reduce exposure and look for greater potential opportunities. The counter trend helps mitigate downside volatility and momentum crashes that are commonly associated with momentum based strategies. This is an important element of our risk management for trades ranging from 60-300 days.
 

Commonly Followed Indicators = No Edge

In the same example of Disney below, we have two commonly followed indicators: RSI and MACD. As you can see, both of these are full of price noise and volatility. These indicators do not paint a clear direction for investors in terms of price strength or price exhaustion. These commonly followed technical indicators cause many false signals (as you can see below represented in the red circles). These false signals create that whipsaw in-and-out behavior that doesn’t allow technical traders to experience full appreciation.