Author Topic: Dual Momentum Investing  (Read 214799 times)

PathtoFIRE

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Re: Dual Momentum Investing
« Reply #200 on: April 23, 2015, 11:05:13 AM »
so all equities dont necessarily have to be negative over the look back window to move to bonds.  the short term note was as high as 6% in the real estate bubble of 2008.  so you just compare all 4 ... its really simple and you just check it once a month and realocate if needed.

Good point, I was being careless with language. Short term notes were even returning around 3% return over a 6 month lookback as late as 2011 it looks like. On the PERFchart, you can toggle one of the up to 10 funds/stocks, and the returns on everything else is reported in relation to that, so I was toggling short term treasuries, and in that sense, there are points where everything else is negative _in relation to_ the treasuries.

hodedofome

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Re: Dual Momentum Investing
« Reply #201 on: April 23, 2015, 03:39:44 PM »
In the past 5 years there have been no sustained down periods in U.S. Stocks, which is why any time that the system told you to switch to another asset class, you were quickly given a signal to switch back. It's called getting 'whipsawed' and it's going to happen. You just have to accept it. It's incredibly frustrating for a lot of people which is why most give up on the system. Just as you give up or say 'screw it I'll just buy and hold US stocks,' that's when the real bear market happens and you wish you had stuck with the system.

Ed Seykota is a famous (and stupidly successful) trend follower who wrote a song to help cope with the psychological issues of following a systematic approach to trend following. https://youtu.be/LiE1VgWdcQM


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dungoofed

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Re: Dual Momentum Investing
« Reply #202 on: April 23, 2015, 10:37:32 PM »
Ed Seykota is a famous (and stupidly successful) trend follower who wrote a song to help cope with the psychological issues of following a systematic approach to trend following. https://youtu.be/LiE1VgWdcQM

Classic!

* * * * *

Any chance the dual momentum-ers give us a heads up in this thread when they next trade? Might be several years from now but I would like to see how it plays out.

Monkey Uncle

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Re: Dual Momentum Investing
« Reply #203 on: April 24, 2015, 04:43:32 AM »


Why don't you just take the bullet proof dual momentum strategy, and implement it one day earlier?  Just get onto that roller coaster one day earlier, and get off one day earlier.  Wouldn't that give you slightly more gains, and slightly less losses?

To me this does not seem like a logically valid strategy. There are only about 30 days in a month. That means that there are a finite amount of choices you could make to game the system. For instance, why not double bullet proof the strategy and go two days earlier? I mean you'll beat everyone that has thought like you! Also think if everyone did their DM balancing on the 1st. If you decided to do yours on the 15th, would you be half a month early, or half a month late? Well what if you did it on the 22nd? Would you be about 8 days early or would you be 7 days late from the 15th? It would be easy to game if everyone picked the same day, but more than likely people will distribute their choices across all the days of the month making it hard to be one day in front of everyone.

Right. This is the issue I described earlier where I tried to imagine a world in which everyone used dual momentum. Even given this knowledge, It would be very difficult to arbitrage against dual momentum due to varying look back periods, days to make trades, etc.

Which brings me back to what I posted earlier:


Maybe my perception of the market is wrong, but I see it as a positive sum game, where the positive sum is the total market capitalization.  For example is the total market is $1M, and then in the future it is $2M, then $1M in real (at least on paper) wealth has been created, but no more.  So buy and hold index investors would have realized average growth during that period, dual momentum investors would have realized above average growth, and because of the math some other group of rubes has achieved below average market returns for that period. 

So are you telling me if everyone employed a dual momentum strategy that everyone's portfolio would go gang busters, and no one would lose to a bear market?  Lake Wobegon, where every investor is above average?  How is that even mathematically possible?

No, in this hypothetical there would be an asset bubble until all of the capital was used up. Then it would pop and destroy everyone.

The point is that it would be very hard to profit off of this information. In other words it is difficult to impossible to arbitrage away momentum.

Is a ridiculous hypothetical of course, but useful I think.

Not a ridiculous hypothetical situation.  See: tech stocks in 1999, real estate in 2008, tulip bulbs in Holland in 17-something, etc.  Although these bubbles weren't caused by DM per se, they were caused by a large proportion of speculators blindly following momentum.  If anyone was following a DM strategy through these boom-and-bust cycles, they made out like bandits (i.e., they were the smart money).  But what if a large proportion of speculators had been doing DM?  My guess is the busts would have been much quicker and deeper due to everyone bailing out as soon as the trend started to change.  Your sell orders may not have been executed quickly enough to avoid taking a bath.
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hodedofome

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Re: Dual Momentum Investing
« Reply #204 on: April 24, 2015, 05:51:03 AM »
http://blog.alphaarchitect.com/2015/04/21/are-value-investing-and-momentum-investing-robust-anomalies/

Legitimate anomalies can usually be described via a behavioral finance lens:

Can we identify poor psychology in the market? (Why do prices get dislocated along the way)
Can we identify the limits to arbitrage? (Why don’t large pools of capital arbitrage the anomaly away)
There are 2 anomalies that stand out among all other anomalies: Value investing and momentum investing.


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Financial.Velociraptor

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Re: Dual Momentum Investing
« Reply #205 on: April 24, 2015, 08:53:48 AM »
There are 2 anomalies that stand out among all other anomalies: Value investing and momentum investing.

Third "big" anomaly has existed since Black/Scholes defined the options pricing model: the "options smile".  You can find about 30,000 reams of academia on that one, especially the 'negative skew' that favors put premiums over call premiums.  Impossible cry the EFM peeps, yet it has persisted for decades across an entire class of assets despite a clear path to arbitrage.
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hodedofome

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Re: Dual Momentum Investing
« Reply #206 on: April 24, 2015, 09:01:40 AM »
Yeah not my words, it came from the article I posted. I unfortunately don't know enough about options but I do know some very smart people who have said roughly the same as you.


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milesdividendmd

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Re: Dual Momentum Investing
« Reply #207 on: April 24, 2015, 09:20:05 AM »

http://www.optimalmomentum.com/faq.html

The optimal momentum website has a faq which addresses a few common questions posted on this thread such as:
   If momentum investing is so great, why are not more people doing it?
   It usually takes awhile for academic research to work its way into the investment marketplace. We saw that with indexing and value   investing. Public awareness should grow as momentum research information gets assimilated over time.

While the answer probably leaves us all a bit wanting, it is directly from the author/researcher's mouth.

I am still performing a bit of reading/research prior to committing even my madmoney to the approach.  I am, however, appreciative of milesdividendmd's writing on the subject as his coward's series is an enjoyable read.

Thanks jcoz.

The cowards posts were not meant as a persuasive series really.  My blog has always been just a stage for personal musings.

The cowards philosophy is just kind of how I see the world of investing. It's just one slubs perspective.

I am risk averse first and foremost and I truly believe that avoiding left tail risk is the name of the game.

I agree with others that you don't have to hit home runs. But what's more important (from my perspective) is just not hitting into triple plays.

Compounding takes time, most of all, so avoiding Big negative moves that erase long periods of time is a worthwhile goal.

Whether or not it is possible is open to debate.
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milesdividendmd

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Re: Dual Momentum Investing
« Reply #208 on: April 24, 2015, 09:21:32 AM »



Why don't you just take the bullet proof dual momentum strategy, and implement it one day earlier?  Just get onto that roller coaster one day earlier, and get off one day earlier.  Wouldn't that give you slightly more gains, and slightly less losses?

To me this does not seem like a logically valid strategy. There are only about 30 days in a month. That means that there are a finite amount of choices you could make to game the system. For instance, why not double bullet proof the strategy and go two days earlier? I mean you'll beat everyone that has thought like you! Also think if everyone did their DM balancing on the 1st. If you decided to do yours on the 15th, would you be half a month early, or half a month late? Well what if you did it on the 22nd? Would you be about 8 days early or would you be 7 days late from the 15th? It would be easy to game if everyone picked the same day, but more than likely people will distribute their choices across all the days of the month making it hard to be one day in front of everyone.

Right. This is the issue I described earlier where I tried to imagine a world in which everyone used dual momentum. Even given this knowledge, It would be very difficult to arbitrage against dual momentum due to varying look back periods, days to make trades, etc.

Which brings me back to what I posted earlier:


Maybe my perception of the market is wrong, but I see it as a positive sum game, where the positive sum is the total market capitalization.  For example is the total market is $1M, and then in the future it is $2M, then $1M in real (at least on paper) wealth has been created, but no more.  So buy and hold index investors would have realized average growth during that period, dual momentum investors would have realized above average growth, and because of the math some other group of rubes has achieved below average market returns for that period. 

So are you telling me if everyone employed a dual momentum strategy that everyone's portfolio would go gang busters, and no one would lose to a bear market?  Lake Wobegon, where every investor is above average?  How is that even mathematically possible?

No, in this hypothetical there would be an asset bubble until all of the capital was used up. Then it would pop and destroy everyone.

The point is that it would be very hard to profit off of this information. In other words it is difficult to impossible to arbitrage away momentum.

Is a ridiculous hypothetical of course, but useful I think.

Not a ridiculous hypothetical situation.  See: tech stocks in 1999, real estate in 2008, tulip bulbs in Holland in 17-something, etc.  Although these bubbles weren't caused by DM per se, they were caused by a large proportion of speculators blindly following momentum.  If anyone was following a DM strategy through these boom-and-bust cycles, they made out like bandits (i.e., they were the smart money).  But what if a large proportion of speculators had been doing DM?  My guess is the busts would have been much quicker and deeper due to everyone bailing out as soon as the trend started to change.  Your sell orders may not have been executed quickly enough to avoid taking a bath.

The "ridiculous hypothetical" was not the existence of future bubbles. It was 100% of investors adopting dual momentum.
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forummm

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Re: Dual Momentum Investing
« Reply #209 on: April 25, 2015, 01:24:14 PM »
Ed Seykota is a famous (and stupidly successful) trend follower who wrote a song to help cope with the psychological issues of following a systematic approach to trend following. https://youtu.be/LiE1VgWdcQM


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Thanks for posting. I only invest my life savings in ways that can be explained by song. ;)

(j/k --it's a fun addition to the topic)
« Last Edit: April 25, 2015, 01:29:51 PM by forummm »

AlanStache

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Re: Dual Momentum Investing
« Reply #210 on: April 25, 2015, 01:53:56 PM »
I think I have looked into momentum strategies in past, basic opinion at the time was yes sort of but not worth the effort/added risk of doing the unconventional.  Seeing wipsaws in back testing does not give confidence either.  Need to read up a bit more from the links above then write some code.

thanks for the great read.
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mtnrider

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Re: Dual Momentum Investing
« Reply #211 on: April 25, 2015, 03:09:40 PM »
Is accurate daily data is available for the four funds?

It might be fun to write a little program to backtest the algorithms (trust but verify  :) ).  Oh, and see how thing would have gone with minor changes.

AlanStache

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Re: Dual Momentum Investing
« Reply #212 on: April 25, 2015, 03:44:37 PM »
Is accurate daily data is available for the four funds?

It might be fun to write a little program to backtest the algorithms (trust but verify  :) ).  Oh, and see how thing would have gone with minor changes.

yahoo finance is a good/ok source of free historical data.  can be pulled programmatically as csv files.  they dont seem to mind people pulling large amounts of data, also includes an adjusted close that accounts for splits/dividends.  google finance does not have an adjusted close (last time I checked).  back testing over 10 years dividends add up.
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GGNoob

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Re: Dual Momentum Investing
« Reply #213 on: April 25, 2015, 04:11:20 PM »
Is accurate daily data is available for the four funds?

It might be fun to write a little program to backtest the algorithms (trust but verify  :) ).  Oh, and see how thing would have gone with minor changes.

You can back-test on https://www.portfoliovisualizer.com/ using the timing models section.

forummm

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Re: Dual Momentum Investing
« Reply #214 on: April 25, 2015, 07:06:54 PM »
I finally read this thread today. Still processing through some thoughts. But the big one I have now is market timing. People repeatedly said in posts that everyone says market timing is bad. And that Ben Graham is one big reason why, since he was so opposed to market timing. And his disciple Buffett took on that torch.

But Graham was explicitly for market timing.

He was for more narrow movements in portfolio allocation (never less than 25% in either stocks or bonds). But clearly advocated (and practiced) reallocating his portfolio between those two asset classes based on whether he determined one was sufficiently "too expensive" compared to the other.

Graham was also timing the market on the basis of individual stock selections. Again, based on when he thought the movements of the market made a particular stock "too cheap", he would buy into that stock. And sell it if it got "too expensive".

Buffett does something similar, except that he does almost all buying and very little selling. But the reason for that is (I think) mostly the taxes he's trying to avoid and the fact that his positions are so huge that he would depress the stock price as he sold it off. He might think Coke is overpriced, but his capital gains on it since ~1986 when he bought it, plus the fact that he holds 10% of the company, make it just too expensive to sell relative to other investments available.

I don't know that this give me any great insight into dual momentum investing (a dumb name BTW). But just thinking through the implications of the strategy.

forummm

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Re: Dual Momentum Investing
« Reply #215 on: April 26, 2015, 11:17:19 AM »
I noticed that all the backtesting shown on this site looks at the last 10 or 20 years. The market performance during this time is a little unusual in ways that would seem to bias results in favor of a DM strategy as articulated by MDMD (6-month lookback, relative strength, 1-fund holding, etc). For example, two huge crashes within 10 years of each other, both were preceeded by a bull market, and both crashes were slow enough and deep enough that the market timer could switch to another fund well before the bottom, and the bull markets following the crashes were slow enough at first such that the market timer could jump back in before the losing too much growth, etc. I thought I would see what the most data available was and simulate that.

I think I discovered where there isn't any free lunch. And that the flaws can be substantively deleterious to short- and long-term performance. I used the Vanguard funds with the longest-available data on https://www.portfoliovisualizer.com/test-market-timing-model to conduct MDMD's DM strategy as best as possible from 1986 (or 1987 or 1988 for some funds) through 2014. The 500 Index fund (VFINX), the Small Cap Index Fund (NAESX), and International Growth Fund (VWIGX) were available from 1985 onwards. I was unable to find another international fund available for as lengthy a time period. I also looked at results with that fund excluded. The bond funds most similar to "quality" that investors normally pile into during crashes and with data available were GNMA (VFIIX), Long-Term Treasury (VUSTX), Total Bond (VBMFX), LT Investment Grade (VWESX), ST Investment Grade (VFSTX). These were available starting between 1986 and 1988 depending on the fund. You can argue about which one you think is the "right" one that you would use in a DM strategy. But I looked at them all. I won't include links to all of the simulation results because they are absurdly long URLs. But I will include one and you can easily substitute the fund call letters to see the results for yourself. Note that all these examples are ignoring any transaction costs (through bid/ask spreads, trading fees, capital gains taxes, etc) and assume reinvestment of dividends.

Example 1 LT Treasury 1987+:
Timing portfolio $90,960
Stock market $159,503
Over ~30 years, you end up with about half as much as a buy-and-hold investor, and lag the bond portfolio for about 25 of the years. There's a +$20k positive difference by omitting international.

Example 2 GNMA 1986+:
Timing portfolio $191,625
Stock market $185,465
There's a -$35k difference by omitting international.

Example 3 Total Bond 1988+:
Timing portfolio $177,762
Stock market $156,984
Even with avoiding the 1987 flash crash, the timing portfolio only slightly outperforms. Omitting international has a -$12k difference.

Example 4 LT investment grade 1986+
Timing portfolio $127,063
Stock market $185,465
Omitting international has a -$23k difference.

Example 5 ST investment grade 1986+
Timing portfolio $171,083
Stock market $185,465
Omitting international has a -$40k difference.

So this tells me that the DM strategy, when tested on an out-of-sample set of data, fails miserably. The results posted earlier in the thread from the last 10 or 20 years showed ending portfolios of ~4X the buy-and-hold. So the fact that extending the sample backwards just 10 or 20 years results in similar or much worse performance shows how terrible the DM strategy performs during that extra period--even in the period that excludes the 1987 crash.

In this sequence of returns, for some of these examples, a retiree would go bust quickly. Since their portfolio dives in the first portion of the simulation period and only very slowly recovers 2 decades later, a retiree would be selling a very high percentage of their portfolio to live on. In example 1, the portfolio without any withdrawals would still be below the starting value after 6 years.

Example simulation URL (note you can't just click on the link here to have all the options load, you have to copy and past the URL Mod Edit: Fixed link. Click away. /end edit.):
https://www.portfoliovisualizer.com/test-market-timing-model?s=y&timingWeights[2]=0&endYear=2014&volatilityPeriodWeight=0&movingAverageType=1&windowSize=6&timingUnits[2]=2&timingModel=4&volatilityWindowSize=0&startYear=1985&assetsToHold=1&multipleTimingPeriods=false&timingUnits[1]=2&outOfMarketAssetType=1&timingPeriods[0]=5&timingWeights[0]=100&volatilityWindowSizeInDays=0&riskControl=false&symbols=VUSTX%2C+VFINX%2C+NAESX%2C+VWIGX&riskWindowSizeInDays=0&timingUnits[0]=2&timingWeights[1]=0&windowSizeInDays=105&volatilityPeriodUnit=1&riskWindowSize=10&rebalancePeriod=1
« Last Edit: April 26, 2015, 01:41:39 PM by arebelspy »

GGNoob

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Re: Dual Momentum Investing
« Reply #216 on: April 26, 2015, 02:23:34 PM »
Here's the results using just 3 funds...S&P 500, International Growth, and a GNMA fund. The test goes back to 1986. The timing portfolio underperforms until 2002. Those first 16 years of underperformance would make it incredibly hard to stick to when a simple buy and hold approach would have done better.

forummm

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Re: Dual Momentum Investing
« Reply #217 on: April 26, 2015, 02:41:32 PM »
Here's the results using just 3 funds...S&P 500, International Growth, and a GNMA fund. The test goes back to 1986. The timing portfolio underperforms until 2002. Those first 16 years of underperformance would make it incredibly hard to stick to when a simple buy and hold approach would have done better.

And that underperforms just buying and holding emerging markets:
https://www.portfoliovisualizer.com/backtest-asset-class-allocation?s=y&portfolio3=Custom&portfolio2=Custom&portfolio1=Custom&annualOperation=0&initialAmount=10000&EmergingMarket1=100&endYear=2014&mode=2&inflationAdjusted=true&annualAdjustment=0&startYear=1986&rebalanceType=1&annualPercentage=0.0

Doing this kind of sensitivity analysis shows how vulnerable these kinds of systems are to overfitting by using backtesting. Just by using a slightly different bond fund (one that is still safe, and has returned about the same amount over time), your portfolio ends up being half as much. And whether you include international or not, depending on which bond fund you use, has a similar effect of changing the final value by 4x your starting portfolio amount. There's a lot of increased risk to this system that doesn't show up in the standard deviation.

Monkey Uncle

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Re: Dual Momentum Investing
« Reply #218 on: April 26, 2015, 02:59:54 PM »
Here's the results using just 3 funds...S&P 500, International Growth, and a GNMA fund. The test goes back to 1986. The timing portfolio underperforms until 2002. Those first 16 years of underperformance would make it incredibly hard to stick to when a simple buy and hold approach would have done better.

Many of the back tests up-thread also showed that long period of underperformance in the 1990s.  If you stuck with it, ultimately you were vindicated and ended up with twice as much money.  But at what point does your wise patience start to feel like waiting for the Great Pumpkin?

I've run a number of back tests as well, and generally found that the reduction in maximum drawdown does seem to be consistent across most scenarios, even compared to a balanced portfolio.  So perhaps there is something to that aspect of it.
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forummm

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Re: Dual Momentum Investing
« Reply #219 on: April 26, 2015, 03:57:40 PM »
Here's the results using just 3 funds...S&P 500, International Growth, and a GNMA fund. The test goes back to 1986. The timing portfolio underperforms until 2002. Those first 16 years of underperformance would make it incredibly hard to stick to when a simple buy and hold approach would have done better.

Many of the back tests up-thread also showed that long period of underperformance in the 1990s.  If you stuck with it, ultimately you were vindicated and ended up with twice as much money.  But at what point does your wise patience start to feel like waiting for the Great Pumpkin?

I've run a number of back tests as well, and generally found that the reduction in maximum drawdown does seem to be consistent across most scenarios, even compared to a balanced portfolio.  So perhaps there is something to that aspect of it.

I suppose. But investing such that from the same starting portfolio value you get a 30% drawdown from $100k (and miss most of the rebound) is a worse scenario than a 50% drawdown from $250k (and you get all of the rebound).

forummm

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Re: Dual Momentum Investing
« Reply #220 on: April 26, 2015, 04:33:44 PM »
And if you are spending most years getting bond-like performance with stock-like volatility, that seems suboptimal. Especially for people who are attracted to the idea that you could have less risk of dramatic portfolio decline.

milesdividendmd

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Re: Dual Momentum Investing
« Reply #221 on: April 27, 2015, 12:56:38 AM »
I noticed that all the backtesting shown on this site looks at the last 10 or 20 years. The market performance during this time is a little unusual in ways that would seem to bias results in favor of a DM strategy as articulated by MDMD (6-month lookback, relative strength, 1-fund holding, etc). For example, two huge crashes within 10 years of each other, both were preceeded by a bull market, and both crashes were slow enough and deep enough that the market timer could switch to another fund well before the bottom, and the bull markets following the crashes were slow enough at first such that the market timer could jump back in before the losing too much growth, etc. I thought I would see what the most data available was and simulate that.

I think I discovered where there isn't any free lunch. And that the flaws can be substantively deleterious to short- and long-term performance. I used the Vanguard funds with the longest-available data on https://www.portfoliovisualizer.com/test-market-timing-model to conduct MDMD's DM strategy as best as possible from 1986 (or 1987 or 1988 for some funds) through 2014. The 500 Index fund (VFINX), the Small Cap Index Fund (NAESX), and International Growth Fund (VWIGX) were available from 1985 onwards. I was unable to find another international fund available for as lengthy a time period. I also looked at results with that fund excluded. The bond funds most similar to "quality" that investors normally pile into during crashes and with data available were GNMA (VFIIX), Long-Term Treasury (VUSTX), Total Bond (VBMFX), LT Investment Grade (VWESX), ST Investment Grade (VFSTX). These were available starting between 1986 and 1988 depending on the fund. You can argue about which one you think is the "right" one that you would use in a DM strategy. But I looked at them all. I won't include links to all of the simulation results because they are absurdly long URLs. But I will include one and you can easily substitute the fund call letters to see the results for yourself. Note that all these examples are ignoring any transaction costs (through bid/ask spreads, trading fees, capital gains taxes, etc) and assume reinvestment of dividends.

Example 1 LT Treasury 1987+:
Timing portfolio $90,960
Stock market $159,503
Over ~30 years, you end up with about half as much as a buy-and-hold investor, and lag the bond portfolio for about 25 of the years. There's a +$20k positive difference by omitting international.

Example 2 GNMA 1986+:
Timing portfolio $191,625
Stock market $185,465
There's a -$35k difference by omitting international.

Example 3 Total Bond 1988+:
Timing portfolio $177,762
Stock market $156,984
Even with avoiding the 1987 flash crash, the timing portfolio only slightly outperforms. Omitting international has a -$12k difference.

Example 4 LT investment grade 1986+
Timing portfolio $127,063
Stock market $185,465
Omitting international has a -$23k difference.

Example 5 ST investment grade 1986+
Timing portfolio $171,083
Stock market $185,465
Omitting international has a -$40k difference.

So this tells me that the DM strategy, when tested on an out-of-sample set of data, fails miserably. The results posted earlier in the thread from the last 10 or 20 years showed ending portfolios of ~4X the buy-and-hold. So the fact that extending the sample backwards just 10 or 20 years results in similar or much worse performance shows how terrible the DM strategy performs during that extra period--even in the period that excludes the 1987 crash.

In this sequence of returns, for some of these examples, a retiree would go bust quickly. Since their portfolio dives in the first portion of the simulation period and only very slowly recovers 2 decades later, a retiree would be selling a very high percentage of their portfolio to live on. In example 1, the portfolio without any withdrawals would still be below the starting value after 6 years.

Example simulation URL (note you can't just click on the link here to have all the options load, you have to copy and past the URL Mod Edit: Fixed link. Click away. /end edit.):
https://www.portfoliovisualizer.com/test-market-timing-model?s=y&timingWeights[2]=0&endYear=2014&volatilityPeriodWeight=0&movingAverageType=1&windowSize=6&timingUnits[2]=2&timingModel=4&volatilityWindowSize=0&startYear=1985&assetsToHold=1&multipleTimingPeriods=false&timingUnits[1]=2&outOfMarketAssetType=1&timingPeriods[0]=5&timingWeights[0]=100&volatilityWindowSizeInDays=0&riskControl=false&symbols=VUSTX%2C+VFINX%2C+NAESX%2C+VWIGX&riskWindowSizeInDays=0&timingUnits[0]=2&timingWeights[1]=0&windowSizeInDays=105&volatilityPeriodUnit=1&riskWindowSize=10&rebalancePeriod=1

Before getting into the nitty-gritty here, let me just thank you for your specific criticism of the strategy.

I find this sort of discussion very useful and truly appreciate your effort.

Now for the specifics of the points that you bring up.

To credibly call something a dual momentum strategy it must fulfill a 2 simple criteria.

1: It must include 2 imperfectly correlated assets, Plus cash.

2: Cash can be simply cash, or short-term treasuries. You can make an argument for total bond market with an average duration of about five years, but this is about as aggressive as you can possibly go. In other words "cash" must be a risk-free asset. It cannot be long-term treasuries which have interest-rate risk. It cannot be high-yield bonds which have credit risk. And it certainly cannot be mortgage-backed securities (GNMA) which have both interest rate risk and credit risk.

The idea is to harness absolute momentum, which means exiting the market when the look back period signals a bear market.

Finally looking at your back tests, I have absolutely no idea what you are actually testing, but it certainly is not dual momentum.

For instance in your example 1 you cite long-term treasuries from 1987 on. But if you back test VUSTX versus VFINX, without short-term treasuries for this time period you will find out the timing portfolio has a return of 11.3% with a Max drawdown 23.51% versus a return of 10.4% with a max drawdown of 50.39% for the stock portfolio. So even using a flawed dual momentum strategy with no short-term treasuries or safe assets it still beats 100% stocks with one half of the max drawdown!  I'll take it!

That there will be long periods of underperformance with this active strategy is beyond obvious. this is true for every active strategy, even Warren Buffet's, in retrospect.

But it is worth noting that dual momentum is at its best when the market is at its worst and that you will still compound in years when you're "losing" to the market. So you're winning you're just not winning as much as the stock market for these time periods.

So it is certainly not reasonable to expect consistent outperformance of this or any strategy, but it is very reasonable to expect markedly decreased drawdowns and excellent long-term performance.

The final point to make is that Antonacci has backtest data going back to 1971 for all of his dual momentum strategies on his site, using index data.  I encourage you to read his papers and his book so that you can gain a better understanding of the strategy.
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milesdividendmd

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Re: Dual Momentum Investing
« Reply #222 on: April 27, 2015, 01:02:45 AM »
Here's the results using just 3 funds...S&P 500, International Growth, and a GNMA fund. The test goes back to 1986. The timing portfolio underperforms until 2002. Those first 16 years of underperformance would make it incredibly hard to stick to when a simple buy and hold approach would have done better.

And that underperforms just buying and holding emerging markets:
https://www.portfoliovisualizer.com/backtest-asset-class-allocation?s=y&portfolio3=Custom&portfolio2=Custom&portfolio1=Custom&annualOperation=0&initialAmount=10000&EmergingMarket1=100&endYear=2014&mode=2&inflationAdjusted=true&annualAdjustment=0&startYear=1986&rebalanceType=1&annualPercentage=0.0

Doing this kind of sensitivity analysis shows how vulnerable these kinds of systems are to overfitting by using backtesting. Just by using a slightly different bond fund (one that is still safe, and has returned about the same amount over time), your portfolio ends up being half as much. And whether you include international or not, depending on which bond fund you use, has a similar effect of changing the final value by 4x your starting portfolio amount. There's a lot of increased risk to this system that doesn't show up in the standard deviation.

This is not sensitivity analysis.  This is just bad modeling on your part.

It's easy to find a single asset class that outperforms any strategy in retrospect.  Unless your strategy has always been to hold 100% EM stocks, your point is meaningless.
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hodedofome

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Re: Dual Momentum Investing
« Reply #223 on: April 27, 2015, 08:50:46 AM »
Thanks MDMD, you saved me some keystrokes. I'll add to your post that we need to first decide what the benchmark is going to be before we make any conclusions whatsoever. Is the benchmark just US stocks? Who gets to cherry pick the benchmark like that? It is much more realistic to use the entire global market, rather that cherry pick 1 country out of all the other possibilities. Since the dual momentum strategy as mostly described on this post uses both worldwide stocks and bonds, we should probably compare it to a balanced portfolio, rather than a 100% stock portfolio. ESPECIALLY if the small timeperiod that we're cherry picking to compare (late '80s to 2000) is literally the best period of US stocks in all of history. That to me sounds incredibly biased. Rather let's compare much greater periods of time than just that one.

FWIW a balanced portfolio of 30% US, 30% Int'l and 40% Total US Bonds from 1986-2014 did 9.09% CAGR, -22.32% Drawdown and 11.45% Std Dev.

You are absolutely correct that there is a good bit of sensitivity to what asset classes you throw in the momentum portfolio. Especially if you are only choosing 1 asset class at a time. You have to really think through which asset classes you are going to pick. It is the most important choice in a system like this. The lookback window is of much less importance than the choice of asses classes.
« Last Edit: April 27, 2015, 09:16:27 AM by hodedofome »

forummm

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Re: Dual Momentum Investing
« Reply #224 on: April 27, 2015, 10:07:45 AM »
Regarding: http://forum.mrmoneymustache.com/investor-alley/dual-momentum-investing/msg641783/#msg641783
and http://forum.mrmoneymustache.com/investor-alley/dual-momentum-investing/msg641785/#msg641785

I'm not sure I understand the cricitism of my analysis. You say you're not sure what I did, but I provided a link so that it was perfectly replicable by anyone. You argue that LT Treasuries was not the same as cash, but then later say that it performed the way you wanted it to. However, my impression is that this still causes you to dismiss the overall result from that analysis--that DM significantly underperformed buy-and-hold the last 30 years. And you said I wasn't conducting sensitivity analysis, but maybe you were just confused as to which analysis I meant. Adding additional out-of-sample years and substituting different asset classes shows how robust or not the strategy is (or, to put it differently, how sensitive it is to the specific inputs). Or perhaps you misinterpreted my comment about the perils of using backtesting as being about sensitivity analysis. The point I was making there is that by using backtesting you can always look like your strategy is genius. I think emerging markets are going to outperform developed markets for the next 30 years, so it's a reasonable strategy to buy-and-hold them. It bears similar risks of dramatic underperformance for substantial periods as does DM.

Prospectively, LT Treasuries are not entirely risk free because of interest rate risk. But during the sample period, interest rate risk was not much of an issue. Rates were generally trending down. And during the key period that mattered (the 1987 crash), LT Treasuries increased in value as you would expect because it's a safe asset. In the short term, and when we know in hindsight that interest rates did not increase, it functions like tradeable cash. Thinking prospectively, there is interest rate risk. But in hindsight, there was no downward change in asset prices due to rising interest rates.

http://quote.morningstar.com/fund/chart.aspx?t=VUSTX&region=USA&culture=en-US&statePara=%7Bsecurities%3A%5B%7Bn%3A%22Vanguard%20Long-Term%20Treasury%20Inv%22%2Cids%3A%22FOUSA00FTW%7C0P00002T15%7CCU%24%24%24%24%24USD%7C1%7C1%7CFO%7C1986-5-19%7C%7C%7Cfalse%7CUSA%7C19%22%7D%2C%7Bn%3A%22Long%20Government%22%2Cids%3A%22%24FOCA%24GL%24%24%7C%24FOCA%24GL%24%24%7CCU%24%24%24%24%24USD%7C1%7C1%7CCA%7C%7C%7C%7Ctrue%7CUSA%7C0%22%7D%2C%7Bn%3A%22Barclays%20US%20Agg%20Bond%20TR%20USD%22%2Cids%3A%22XIUSA000MC%7C0P00001G5L%7CCU%24%24%24%24%24USD%7C1%7C1%7CXI%7C%7C%7C%7Ctrue%7CUSA%7C0%22%7D%5D%2CchartType%3A%22GrowthChart%22%2Crange%3A%221987-5-19%7C1988-1-1%22%2Cperiod%3A9%2Cregion%3A%22USA%22%2Ctc%3A%22USD%22%2CisD%3A%220%22%2CisR%3A%220%22%2CrM%3A3%2Cscale%3A%221%22%2CbMenu%3A%22%22%2Csma%3A%220%2C0%2C0%22%7D

I do not have ready access to the $50 book, so I can't see what data was used and cannot comment on it. I was going only on what had been posted in this forum. But I think an independent analysis of the strategy, showing that it is robust to different inputs and time periods, would be necessary to demonstrate that this strategy has merit for investing my life savings. So far I have not seen that.

I think the point about underperformance is really important. Underperforming--and dramatically so--may lead one to abandon the strategy. And the early dramatic underperformance may lead one to portfolio failure. One reason any of these or Logan's backtesting ended up with comparable results in some scenarios for DM is that there was no portfolio withdrawal. Unfortunately PortfolioVisualizer does not include the option to simluate withdrawals with market timing strategies.

forummm

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Re: Dual Momentum Investing
« Reply #225 on: April 27, 2015, 10:11:53 AM »
Thanks MDMD, you saved me some keystrokes. I'll add to your post that we need to first decide what the benchmark is going to be before we make any conclusions whatsoever. Is the benchmark just US stocks? Who gets to cherry pick the benchmark like that? It is much more realistic to use the entire global market, rather that cherry pick 1 country out of all the other possibilities. Since the dual momentum strategy as mostly described on this post uses both worldwide stocks and bonds, we should probably compare it to a balanced portfolio, rather than a 100% stock portfolio. ESPECIALLY if the small timeperiod that we're cherry picking to compare (late '80s to 2000) is literally the best period of US stocks in all of history. That to me sounds incredibly biased. Rather let's compare much greater periods of time than just that one.

FWIW a balanced portfolio of 30% US, 30% Int'l and 40% Total US Bonds from 1986-2014 did 9.09% CAGR, -22.32% Drawdown and 11.45% Std Dev.

You are absolutely correct that there is a good bit of sensitivity to what asset classes you throw in the momentum portfolio. Especially if you are only choosing 1 asset class at a time. You have to really think through which asset classes you are going to pick. It is the most important choice in a system like this. The lookback window is of much less importance than the choice of asses classes.

In the examples posted in the thread, people used the S&P 500 and one or 2 international funds. And I think all or almost all examples used just 1 fund at a time or showed that using just 1 fund at a time had superior overall returns. Hence my using those same parameters for my analyses. I thought MDMD's point with this whole approach is that you don't need a balanced fund at any point in time because the magic of momentum will get you out of the market before your equities go all the way down and get you back in when they are ready to roar.

milesdividendmd

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Re: Dual Momentum Investing
« Reply #226 on: April 27, 2015, 11:48:40 AM »
Regarding: http://forum.mrmoneymustache.com/investor-alley/dual-momentum-investing/msg641783/#msg641783
and http://forum.mrmoneymustache.com/investor-alley/dual-momentum-investing/msg641785/#msg641785

I'm not sure I understand the cricitism of my analysis. You say you're not sure what I did, but I provided a link so that it was perfectly replicable by anyone. You argue that LT Treasuries was not the same as cash, but then later say that it performed the way you wanted it to. However, my impression is that this still causes you to dismiss the overall result from that analysis--that DM significantly underperformed buy-and-hold the last 30 years. And you said I wasn't conducting sensitivity analysis, but maybe you were just confused as to which analysis I meant. Adding additional out-of-sample years and substituting different asset classes shows how robust or not the strategy is (or, to put it differently, how sensitive it is to the specific inputs). Or perhaps you misinterpreted my comment about the perils of using backtesting as being about sensitivity analysis. The point I was making there is that by using backtesting you can always look like your strategy is genius. I think emerging markets are going to outperform developed markets for the next 30 years, so it's a reasonable strategy to buy-and-hold them. It bears similar risks of dramatic underperformance for substantial periods as does DM.

Prospectively, LT Treasuries are not entirely risk free because of interest rate risk. But during the sample period, interest rate risk was not much of an issue. Rates were generally trending down. And during the key period that mattered (the 1987 crash), LT Treasuries increased in value as you would expect because it's a safe asset. In the short term, and when we know in hindsight that interest rates did not increase, it functions like tradeable cash. Thinking prospectively, there is interest rate risk. But in hindsight, there was no downward change in asset prices due to rising interest rates.

http://quote.morningstar.com/fund/chart.aspx?t=VUSTX&region=USA&culture=en-US&statePara=%7Bsecurities%3A%5B%7Bn%3A%22Vanguard%20Long-Term%20Treasury%20Inv%22%2Cids%3A%22FOUSA00FTW%7C0P00002T15%7CCU%24%24%24%24%24USD%7C1%7C1%7CFO%7C1986-5-19%7C%7C%7Cfalse%7CUSA%7C19%22%7D%2C%7Bn%3A%22Long%20Government%22%2Cids%3A%22%24FOCA%24GL%24%24%7C%24FOCA%24GL%24%24%7CCU%24%24%24%24%24USD%7C1%7C1%7CCA%7C%7C%7C%7Ctrue%7CUSA%7C0%22%7D%2C%7Bn%3A%22Barclays%20US%20Agg%20Bond%20TR%20USD%22%2Cids%3A%22XIUSA000MC%7C0P00001G5L%7CCU%24%24%24%24%24USD%7C1%7C1%7CXI%7C%7C%7C%7Ctrue%7CUSA%7C0%22%7D%5D%2CchartType%3A%22GrowthChart%22%2Crange%3A%221987-5-19%7C1988-1-1%22%2Cperiod%3A9%2Cregion%3A%22USA%22%2Ctc%3A%22USD%22%2CisD%3A%220%22%2CisR%3A%220%22%2CrM%3A3%2Cscale%3A%221%22%2CbMenu%3A%22%22%2Csma%3A%220%2C0%2C0%22%7D

I do not have ready access to the $50 book, so I can't see what data was used and cannot comment on it. I was going only on what had been posted in this forum. But I think an independent analysis of the strategy, showing that it is robust to different inputs and time periods, would be necessary to demonstrate that this strategy has merit for investing my life savings. So far I have not seen that.

I think the point about underperformance is really important. Underperforming--and dramatically so--may lead one to abandon the strategy. And the early dramatic underperformance may lead one to portfolio failure. One reason any of these or Logan's backtesting ended up with comparable results in some scenarios for DM is that there was no portfolio withdrawal. Unfortunately PortfolioVisualizer does not include the option to simluate withdrawals with market timing strategies.

Again what you are testing is not dual momentum, so using this test to criticize dual momentum is utterly meaningless.

If you want to use an international growth strategy then you could pair it with an imperfectly correlated asset such as international value, or domestic value and then include the cash equivalent.   That would be dual momentum.

What you do instead is throw a bunch of correlated assets in a bucket, with no cash equivalent and call it dual momentum.

It is not dual momentum.  It is utter nonsense.  So your conclusions have no relevance to the topic at hand.

You have proven nothing other than combining an illogical collection of asetts in a bucket and using relative strength does not always work.

This is a good criticism of a "throwing darts at a wall" strategy, which noone is advocating.

If you want to test or the robustness of dual momentum, then you must test dual momentum in an out of sample time period, or out of sample market.

You can not test a completely different theory in the same time period and claim that this is sensitivity analysis.  It is no such thing.

In order to intelligently critique a strategy, you must first understand the strategy.  Checking out Dual Momentum from the local library (or at least reading some of the articles on Antonacci's website) would be a very worthwhile investment of your time to this end.
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MDM

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Re: Dual Momentum Investing
« Reply #227 on: April 27, 2015, 12:46:15 PM »
Generic question: is it possible to use the www.portfoliovisualizer.com site to back test DM? 

If "yes", how should the inputs be formulated?  What, if anything, is specifically incorrect about the analyses done above?

If "no", why not?  What other site(s) can one use, and how should the inputs be formulated?

Chuck

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Re: Dual Momentum Investing
« Reply #228 on: April 27, 2015, 12:55:11 PM »
Thanks MDMD, you saved me some keystrokes. I'll add to your post that we need to first decide what the benchmark is going to be before we make any conclusions whatsoever. Is the benchmark just US stocks? Who gets to cherry pick the benchmark like that? It is much more realistic to use the entire global market, rather that cherry pick 1 country out of all the other possibilities. Since the dual momentum strategy as mostly described on this post uses both worldwide stocks and bonds, we should probably compare it to a balanced portfolio, rather than a 100% stock portfolio. ESPECIALLY if the small timeperiod that we're cherry picking to compare (late '80s to 2000) is literally the best period of US stocks in all of history. That to me sounds incredibly biased. Rather let's compare much greater periods of time than just that one.

FWIW a balanced portfolio of 30% US, 30% Int'l and 40% Total US Bonds from 1986-2014 did 9.09% CAGR, -22.32% Drawdown and 11.45% Std Dev.

You are absolutely correct that there is a good bit of sensitivity to what asset classes you throw in the momentum portfolio. Especially if you are only choosing 1 asset class at a time. You have to really think through which asset classes you are going to pick. It is the most important choice in a system like this. The lookback window is of much less importance than the choice of asses classes.

In the examples posted in the thread, people used the S&P 500 and one or 2 international funds. And I think all or almost all examples used just 1 fund at a time or showed that using just 1 fund at a time had superior overall returns. Hence my using those same parameters for my analyses. I thought MDMD's point with this whole approach is that you don't need a balanced fund at any point in time because the magic of momentum will get you out of the market before your equities go all the way down and get you back in when they are ready to roar.
I would just like to say that I really appreciate your contribution to this thread forummm. You took that bad feeling in the pit of my stomache and you justified it with hard numbers.

That said, I couldn't stop myself from taking your test and trying to make it work. So, I took out the small cap and international funds, and just ran it with S&P 500 and Treasuries. "Absolute Momentum" is what MDMD calls it on his website. The results were MUCH better:

(Please copy and paste the full link to your browser, I can't get it to format properly)
https://www.portfoliovisualizer.com/test-market-timing-model?s=y&timingWeights[2]=0&endYear=2014&volatilityPeriodWeight=0&movingAverageType=1&windowSize=6&timingUnits[2]=2&timingModel=4&volatilityWindowSize=0&startYear=1985&assetsToHold=1&multipleTimingPeriods=false&timingUnits[1]=2&outOfMarketAssetType=1&timingPeriods[0]=5&timingWeights[0]=100&volatilityWindowSizeInDays=0&riskControl=false&symbols=VUSTX%2C+VFINX&riskWindowSizeInDays=0&timingUnits[0]=2&timingWeights[1]=0&windowSizeInDays=105&volatilityPeriodUnit=1&riskWindowSize=6&rebalancePeriod=1

I'm inclined to agree with you that there was simply no free lunch that decimates the market with minimal effort. That said, the practice of timing the market between ONLY US Stocks and Treasuries does stand up to your test. I am going to test other periods to see if it holds up.

« Last Edit: April 27, 2015, 12:59:04 PM by Chuck »

sol

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Re: Dual Momentum Investing
« Reply #229 on: April 27, 2015, 01:07:00 PM »
That said, the practice of timing the market between ONLY US Stocks and Treasuries does stand up to your test.

It only stands up to the test due to the particular timing of the last two recession/recovery cycles.  I still haven't seen anything to suggest that it will ever work again.  You can't just mine the data for some theory that worked in the past and say you've discovered the Holy Grail of investing without some justification as to WHY it worked, and should continue to work.  Otherwise you're just picking the winner of a random contest between groundless hypotheses.

There are tons of different theories about timing the market.  They all worked, for a while, which is why they became widely known theories.  If you're theory is "only buy stocks on Tuesdays and only sell on Thursdays" then in some years you will make a killing with that plan, just due to random chance.  That doesn't make the theory any good for this year or any year in the future.

Thus far, all discussion in this thread is the equivalent of that Tuesday/Thursday plan.  I've yet to see any evidence presented about why or how dual momentum investing is supposed to work in the future.

Would you buy a "How to Win the Lottery" book from a lottery winner?

milesdividendmd

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Re: Dual Momentum Investing
« Reply #230 on: April 27, 2015, 01:45:40 PM »
Thanks MDMD, you saved me some keystrokes. I'll add to your post that we need to first decide what the benchmark is going to be before we make any conclusions whatsoever. Is the benchmark just US stocks? Who gets to cherry pick the benchmark like that? It is much more realistic to use the entire global market, rather that cherry pick 1 country out of all the other possibilities. Since the dual momentum strategy as mostly described on this post uses both worldwide stocks and bonds, we should probably compare it to a balanced portfolio, rather than a 100% stock portfolio. ESPECIALLY if the small timeperiod that we're cherry picking to compare (late '80s to 2000) is literally the best period of US stocks in all of history. That to me sounds incredibly biased. Rather let's compare much greater periods of time than just that one.

FWIW a balanced portfolio of 30% US, 30% Int'l and 40% Total US Bonds from 1986-2014 did 9.09% CAGR, -22.32% Drawdown and 11.45% Std Dev.

You are absolutely correct that there is a good bit of sensitivity to what asset classes you throw in the momentum portfolio. Especially if you are only choosing 1 asset class at a time. You have to really think through which asset classes you are going to pick. It is the most important choice in a system like this. The lookback window is of much less importance than the choice of asses classes.

In the examples posted in the thread, people used the S&P 500 and one or 2 international funds. And I think all or almost all examples used just 1 fund at a time or showed that using just 1 fund at a time had superior overall returns. Hence my using those same parameters for my analyses. I thought MDMD's point with this whole approach is that you don't need a balanced fund at any point in time because the magic of momentum will get you out of the market before your equities go all the way down and get you back in when they are ready to roar.
I would just like to say that I really appreciate your contribution to this thread forummm. You took that bad feeling in the pit of my stomache and you justified it with hard numbers.

That said, I couldn't stop myself from taking your test and trying to make it work. So, I took out the small cap and international funds, and just ran it with S&P 500 and Treasuries. "Absolute Momentum" is what MDMD calls it on his website. The results were MUCH better:

(Please copy and paste the full link to your browser, I can't get it to format properly)
https://www.portfoliovisualizer.com/test-market-timing-model?s=y&timingWeights[2]=0&endYear=2014&volatilityPeriodWeight=0&movingAverageType=1&windowSize=6&timingUnits[2]=2&timingModel=4&volatilityWindowSize=0&startYear=1985&assetsToHold=1&multipleTimingPeriods=false&timingUnits[1]=2&outOfMarketAssetType=1&timingPeriods[0]=5&timingWeights[0]=100&volatilityWindowSizeInDays=0&riskControl=false&symbols=VUSTX%2C+VFINX&riskWindowSizeInDays=0&timingUnits[0]=2&timingWeights[1]=0&windowSizeInDays=105&volatilityPeriodUnit=1&riskWindowSize=6&rebalancePeriod=1

I'm inclined to agree with you that there was simply no free lunch that decimates the market with minimal effort. That said, the practice of timing the market between ONLY US Stocks and Treasuries does stand up to your test. I am going to test other periods to see if it holds up.

Your test is still not dual momentum or absolute momentum.  If you substitute short term treasuries for long term treasuries it would be absolute momentum.
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hodedofome

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Re: Dual Momentum Investing
« Reply #231 on: April 27, 2015, 01:47:06 PM »
It's not possible to use portfoliovisualizer.com to test out the strategy as defined by Gary. Just FYI.

brooklynguy

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Re: Dual Momentum Investing
« Reply #232 on: April 27, 2015, 01:49:44 PM »
Thus far, all discussion in this thread is the equivalent of that Tuesday/Thursday plan.  I've yet to see any evidence presented about why or how dual momentum investing is supposed to work in the future.

To be fair, in response to my question in post # 145 above expressing the same concern, Miles identified and attempted to explain the logic behind the dual momentum strategy.  In my view, the most compelling argument he described basically boils down to this:  "we can rely on the same human behavior that caused market gyrations to occur as they did in the past to continue to cause market gyrations to occur in predictable ways in the future."  But, unless I'm misunderstanding it, I still don't find this argument particularly compelling.

MDM

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Re: Dual Momentum Investing
« Reply #233 on: April 27, 2015, 01:50:41 PM »
Generic question: is it possible to use the www.portfoliovisualizer.com site to back test DM? 

If "yes", how should the inputs be formulated?  What, if anything, is specifically incorrect about the analyses done above?

If "no", why not?  What other site(s) can one use, and how should the inputs be formulated?
It's not possible to use portfoliovisualizer.com to test out the strategy as defined by Gary. Just FYI.

Thanks.  Can you (or anyone) elaborate?

arebelspy

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Re: Dual Momentum Investing
« Reply #234 on: April 27, 2015, 01:53:05 PM »
That said, the practice of timing the market between ONLY US Stocks and Treasuries does stand up to your test.

It only stands up to the test due to the particular timing of the last two recession/recovery cycles.  I still haven't seen anything to suggest that it will ever work again.  You can't just mine the data for some theory that worked in the past and say you've discovered the Holy Grail of investing without some justification as to WHY it worked, and should continue to work.  Otherwise you're just picking the winner of a random contest between groundless hypotheses.

There are tons of different theories about timing the market.  They all worked, for a while, which is why they became widely known theories.  If you're theory is "only buy stocks on Tuesdays and only sell on Thursdays" then in some years you will make a killing with that plan, just due to random chance.  That doesn't make the theory any good for this year or any year in the future.

Thus far, all discussion in this thread is the equivalent of that Tuesday/Thursday plan.  I've yet to see any evidence presented about why or how dual momentum investing is supposed to work in the future.

Would you buy a "How to Win the Lottery" book from a lottery winner?

This was my argument earlier as well, asking for a logical reason why it works, and will continue to work, not back tested data of how it has worked (a priori, not a posteriori -- in other words, from reason, not experience).

Thus far, all discussion in this thread is the equivalent of that Tuesday/Thursday plan.  I've yet to see any evidence presented about why or how dual momentum investing is supposed to work in the future.

To be fair, in response to my question in post # 145 above expressing the same concern, Miles identified and attempted to explain the logic behind the dual momentum strategy.  In my view, the most compelling argument he described basically boils down to this:  "we can rely on the same human behavior that caused market gyrations to occur as they did in the past to continue to cause market gyrations to occur in predictable ways in the future."  But, unless I'm misunderstanding it, I still don't find this argument particularly compelling.

Agreed.  Counting on people to be rationally irrational seems like a big gamble to me.
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hodedofome

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Re: Dual Momentum Investing
« Reply #235 on: April 27, 2015, 02:04:55 PM »
Thanks.  Can you (or anyone) elaborate?

For one, Gary uses past returns as being either positive or negative to define an uptrend or downtrend. Portfoliovisualizer only gives you moving averages but not past returns (absolute momentum). Sure you can use moving averages, and it'll be close, but it's not the same thing.

Second, Gary uses absolute momentum for the stock indexes first, and if those don't have absolute momentum, then he switches to Aggregate Bonds. Portfoliovisualizer doesn't allow you to choose the 'safe' asset. You just have to throw it in with the stock indexes.

Third, the international index Gary uses is not available on portfoliovisualizer.com back to the '80s as far as I know. Gary uses Standard & Poor’s 500, MSCI All Country World ex-US (MSCI World ex-US prior to 1988) and Barclays Capital U.S. Aggregate Bond (Barclays Capital U.S. Government and Credit prior to 1976) from here: http://www.optimalmomentum.com/trackrecord3.html

Closest I can get to Gary's implementation on portfoliovisualizer is VFINX, VWIGX and VBMFX. That's S&P 500, Int'l Growth, and Total US Bonds. Using a 12 month lookback and 12 month Moving Average I get:

1988-2014
12.46% CAGR
11.35% Std Dev
-20.27% DD
https://www.portfoliovisualizer.com/test-market-timing-model?s=y&timingWeights[2]=0&endYear=2014&volatilityPeriodWeight=0&movingAverageType=1&windowSize=6&timingUnits[2]=2&timingModel=4&volatilityWindowSize=0&startYear=1985&assetsToHold=1&multipleTimingPeriods=true&timingUnits[1]=2&timingPeriods[2]=6&outOfMarketAssetType=1&timingPeriods[0]=12&timingWeights[0]=100&volatilityWindowSizeInDays=0&riskControl=true&symbols=VFINX%2C+VWIGX%2C+VBMFX&volatilityPeriod=20&riskWindowSizeInDays=0&timingUnits[0]=2&timingPeriods[1]=3&timingWeights[1]=0&windowSizeInDays=105&volatilityPeriodUnit=1&riskWindowSize=12&rebalancePeriod=1

6 Month lookback and 12 month Moving Average I get:

13.38% CAGR
10.68% Std Dev
-17.56% DD
https://www.portfoliovisualizer.com/test-market-timing-model?s=y&timingWeights[2]=0&endYear=2014&volatilityPeriodWeight=0&movingAverageType=1&windowSize=6&timingUnits[2]=2&timingModel=4&volatilityWindowSize=0&startYear=1985&assetsToHold=1&multipleTimingPeriods=true&timingUnits[1]=2&timingPeriods[2]=6&outOfMarketAssetType=1&timingPeriods[0]=12&timingWeights[0]=100&volatilityWindowSizeInDays=0&riskControl=true&symbols=VFINX%2C+VWIGX%2C+VBMFX&volatilityPeriod=20&riskWindowSizeInDays=0&timingUnits[0]=2&timingPeriods[1]=3&timingWeights[1]=0&windowSizeInDays=105&volatilityPeriodUnit=1&riskWindowSize=12&rebalancePeriod=1

Combination 12 month, 6 month, 3 month lookback windows and 12 month moving average I get:

12.90% CAGR
10.80% Std Dev
-15.38% DD
https://www.portfoliovisualizer.com/test-market-timing-model?s=y&timingWeights[2]=33&endYear=2014&volatilityPeriodWeight=0&movingAverageType=1&windowSize=6&timingUnits[2]=2&timingModel=4&volatilityWindowSize=0&startYear=1985&assetsToHold=1&multipleTimingPeriods=true&timingUnits[1]=2&timingPeriods[2]=6&outOfMarketAssetType=1&timingPeriods[0]=12&timingWeights[0]=34&volatilityWindowSizeInDays=0&riskControl=true&symbols=VFINX%2C+VWIGX%2C+VBMFX&volatilityPeriod=20&riskWindowSizeInDays=0&timingUnits[0]=2&timingPeriods[1]=3&timingWeights[1]=33&windowSizeInDays=105&volatilityPeriodUnit=1&riskWindowSize=12&rebalancePeriod=1

Combination 12 month, 6 month, 3 month lookback windows, 20 day volatility, 12 month moving average I get:

14.94% CAGR
9.95% Std Dev
-9.85% DD
https://www.portfoliovisualizer.com/test-market-timing-model?s=y&timingWeights[2]=25&endYear=2014&volatilityPeriodWeight=25&movingAverageType=1&windowSize=6&timingUnits[2]=2&timingModel=4&volatilityWindowSize=0&startYear=1985&assetsToHold=1&multipleTimingPeriods=true&timingUnits[1]=2&timingPeriods[2]=6&outOfMarketAssetType=1&timingPeriods[0]=12&timingWeights[0]=25&volatilityWindowSizeInDays=0&riskControl=true&symbols=VFINX%2C+VWIGX%2C+VBMFX&volatilityPeriod=20&riskWindowSizeInDays=0&timingUnits[0]=2&timingPeriods[1]=3&timingWeights[1]=25&windowSizeInDays=105&volatilityPeriodUnit=1&riskWindowSize=12&rebalancePeriod=1
« Last Edit: April 27, 2015, 02:08:34 PM by hodedofome »

milesdividendmd

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Re: Dual Momentum Investing
« Reply #236 on: April 27, 2015, 02:05:15 PM »
That said, the practice of timing the market between ONLY US Stocks and Treasuries does stand up to your test.

It only stands up to the test due to the particular timing of the last two recession/recovery cycles.  I still haven't seen anything to suggest that it will ever work again.  You can't just mine the data for some theory that worked in the past and say you've discovered the Holy Grail of investing without some justification as to WHY it worked, and should continue to work.  Otherwise you're just picking the winner of a random contest between groundless hypotheses.

There are tons of different theories about timing the market.  They all worked, for a while, which is why they became widely known theories.  If you're theory is "only buy stocks on Tuesdays and only sell on Thursdays" then in some years you will make a killing with that plan, just due to random chance.  That doesn't make the theory any good for this year or any year in the future.

Thus far, all discussion in this thread is the equivalent of that Tuesday/Thursday plan.  I've yet to see any evidence presented about why or how dual momentum investing is supposed to work in the future.

Would you buy a "How to Win the Lottery" book from a lottery winner?

equating momentum or trendfollowing to arbitrary rules like buy on tuesday/sell on thursday, or butter production in bangladesh is a false equivalency.

This ignores the mountain of evidence spanning centuries, that trend following does reproducibly decrease drawdowns, and increase returns in in and out of sample data sets.  This book with 800 years of data might pique your interest:

http://www.amazon.com/dp/1118890973/ref=cm_sw_r_awd_RsZlvb04E7KX8

Similarly relative price momentum has persisted since first described academically in the 80s, and has been backtested for over 200 years: 

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2292544

Perhaps the "story" of momentum isn't your cup of tea.  Fair enough.  (No story could be more convincing to me personally, to each his own.) But to write of this form of lasting and unchanging market anomaly as a groundless hypothesis or as curve fitting just seems lazy and uninformed to the extreme.

As to your claim that dual momentum only worked in since 2000, that is demonstrably false.  Just wrong, wrong, wrong.  Not sure what evidence you considered for that flimsy claim, (feel free to share it) but here is convincing evidence to the contrary.

http://www.optimalmomentum.com/trackrecord3.html

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Re: Dual Momentum Investing
« Reply #237 on: April 27, 2015, 02:16:17 PM »
The last two recession/bull market cycles are the reason the last 28 years looks good for Absolute Momentum, but what about looking at different 30 year periods? Is there a site that this can be looked at? How would you check that?

milesdividendmd

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Re: Dual Momentum Investing
« Reply #238 on: April 27, 2015, 02:23:13 PM »
The last two recession/bull market cycles are the reason the last 28 years looks good for Absolute Momentum, but what about looking at different 30 year periods? Is there a site that this can be looked at? How would you check that?

So look at the results from 1972-2000, a 28 year period that does not include the last 2 bear markets. 

http://www.optimalmomentum.com/trackrecord3.html
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hodedofome

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Re: Dual Momentum Investing
« Reply #239 on: April 27, 2015, 02:25:09 PM »
Taken from Meb Faber's paper (originally written in 2006, updated in 2013, I've posted this before on this thread and I'm pretty sure nobody has read it...) http://www.ffplan.com/docs/gtaa_paper.pdf I'm literally going to have to cut and paste screenshots here because I'm almost certain nobody will read the links I've provided.

S&P 500 using the 10 month moving average as a timing signal, since 1901


Graph of the same


Drawdowns


Using S&P 500, MSCI EAFE, REITs, US 10 Yr Treasury Bonds, Commodities, and Treasury Bills for 'safe' asset with the 10 month moving average timing signal


Using different moving average lengths for the timing signal


Using the 10 month moving average and combination 1,3,6,12 month returns on an expanded group of asset classes (total of 13), buying the top 3 or top 6

arebelspy

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Re: Dual Momentum Investing
« Reply #240 on: April 27, 2015, 02:41:17 PM »
That said, the practice of timing the market between ONLY US Stocks and Treasuries does stand up to your test.

It only stands up to the test due to the particular timing of the last two recession/recovery cycles.  I still haven't seen anything to suggest that it will ever work again.  You can't just mine the data for some theory that worked in the past and say you've discovered the Holy Grail of investing without some justification as to WHY it worked, and should continue to work.  Otherwise you're just picking the winner of a random contest between groundless hypotheses.

There are tons of different theories about timing the market.  They all worked, for a while, which is why they became widely known theories.  If you're theory is "only buy stocks on Tuesdays and only sell on Thursdays" then in some years you will make a killing with that plan, just due to random chance.  That doesn't make the theory any good for this year or any year in the future.

Thus far, all discussion in this thread is the equivalent of that Tuesday/Thursday plan.  I've yet to see any evidence presented about why or how dual momentum investing is supposed to work in the future.

Would you buy a "How to Win the Lottery" book from a lottery winner?

equating momentum or trendfollowing to arbitrary rules like buy on tuesday/sell on thursday, or butter production in bangladesh is a false equivalency.

This ignores the mountain of evidence spanning centuries, that trend following does reproducibly decrease drawdowns, and increase returns in in and out of sample data sets.

That.  Doesn't.  Matter.

You keep going back to historical data, which is irrelevant to the question we're asking.

If we backtested and found that a rule of "invest every 7th Tuesday exept in months starting with J, then skip, and sell exactly 19 days later and you'd have beat the market after taxes by 5% annually, stretching back centuries," would you invest in it?

Now I know you're going to tell me this example is a false equivalency, but I promise you it's not, because I'm not comparing that strategy to dual momentum, I'm using it as an illustration as to why back tested data is irrelevant when we're talking about why a strategy works.

If that 7th Tuesday strategy did backtest well, and someone asked "why does it work" -- you'd be at a loss for words.  Maybe it's done it long enough that you're willing to give it a shot.  And that's fine for you. 

But we're not asking "has this worked historically."  We're asking that equivalent of "why does it work" question.

I really don't see how we could be clearer, but you keep coming back to the same answers which don't answer what we're asking, so clearly we aren't communicating something right.

Can you answer why a dual momentum strategy should work going forward without using any previous historical data or saying "it empirically has worked" or anything like that?
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milesdividendmd

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Re: Dual Momentum Investing
« Reply #241 on: April 27, 2015, 02:48:22 PM »
That said, the practice of timing the market between ONLY US Stocks and Treasuries does stand up to your test.

It only stands up to the test due to the particular timing of the last two recession/recovery cycles.  I still haven't seen anything to suggest that it will ever work again.  You can't just mine the data for some theory that worked in the past and say you've discovered the Holy Grail of investing without some justification as to WHY it worked, and should continue to work.  Otherwise you're just picking the winner of a random contest between groundless hypotheses.

There are tons of different theories about timing the market.  They all worked, for a while, which is why they became widely known theories.  If you're theory is "only buy stocks on Tuesdays and only sell on Thursdays" then in some years you will make a killing with that plan, just due to random chance.  That doesn't make the theory any good for this year or any year in the future.

Thus far, all discussion in this thread is the equivalent of that Tuesday/Thursday plan.  I've yet to see any evidence presented about why or how dual momentum investing is supposed to work in the future.

Would you buy a "How to Win the Lottery" book from a lottery winner?

equating momentum or trendfollowing to arbitrary rules like buy on tuesday/sell on thursday, or butter production in bangladesh is a false equivalency.

This ignores the mountain of evidence spanning centuries, that trend following does reproducibly decrease drawdowns, and increase returns in in and out of sample data sets.

That.  Doesn't.  Matter.

You keep going back to historical data, which is irrelevant to the question we're asking.

If we backtested and found that a rule of "invest every 7th Tuesday exept in months starting with J, then skip, and sell exactly 19 days later and you'd have beat the market after taxes by 5% annually, stretching back centuries," would you invest in it?

Now I know you're going to tell me this example is a false equivalency, but I promise you it's not, because I'm not comparing that strategy to dual momentum, I'm using it as an illustration as to why back tested data is irrelevant when we're talking about why a strategy works.

If that 7th Tuesday strategy did backtest well, and someone asked "why does it work" -- you'd be at a loss for words.  Maybe it's done it long enough that you're willing to give it a shot.  And that's fine for you. 

But we're not asking "has this worked historically."  We're asking that equivalent of "why does it work" question.

I really don't see how we could be clearer, but you keep coming back to the same answers which don't answer what we're asking, so clearly we aren't communicating something right.

Can you answer why a dual momentum strategy should work going forward without using any previous historical data or saying "it empirically has worked" or anything like that?


ARS.

With all due respect I'm calling bullshit on this premise.  And I will write an entire blog post on the falseness of your premise that people choose indexing because it has a convincing story, a priori.  You are fooling yourself IMO.

People choose indexing for the same reason they choose any strategy.  Because they think it will provide superior results, BASED ON PAST DATA.  (WHich is a smart conclusion pased on PAST DATA.) All of the efficient market talk is post facto attribution events that have already transpired.

I've already given you my post facto attribution for why I believe momentum has worked and will continue to work.  Because human investors and institutions chase performance. 

If that story doesn't ring true to you, fair enough, but to claim that all strategies other than your own strategy are equivalent, simply because they don't agree with your own personal vision for how the market works is solipsistic.

There is value in robustness testing a strategy with out of sample testing.  There is value in seeing if an anomaly persists AFTER it is described.  If you don't see the value in this, then you don't really understand the scientific method of testing ones hypotheses.
« Last Edit: April 27, 2015, 02:55:48 PM by milesdividendmd »
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hodedofome

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Re: Dual Momentum Investing
« Reply #242 on: April 27, 2015, 02:58:00 PM »
http://blog.alphaarchitect.com/2015/04/21/are-value-investing-and-momentum-investing-robust-anomalies/ I think I already posted this...

Legitimate anomalies can usually be described via a behavioral finance lens:

Can we identify poor psychology in the market? (Why do prices get dislocated along the way)
Can we identify the limits to arbitrage? (Why don’t large pools of capital arbitrage the anomaly away)
There are 2 anomalies that stand out among all other anomalies: Value investing and momentum investing.

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Re: Dual Momentum Investing
« Reply #243 on: April 27, 2015, 03:07:16 PM »
Can you answer why a dual momentum strategy should work going forward without using any previous historical data or saying "it empirically has worked" or anything like that?

I have some vague answers for that question.  I don't generally ask people for answers without having some idea of what I might expect in response.

As we laid out earlier, the success of this strategy hinges upon choosing a lookback period that gives you useful signals of when to enter and exit the asset classes you've chosen.  It should outperform a passive index investor if the market moves in predictable cycles, like every 10% drop over a 6 month period eventually becomes a 20% or greater drop, or something equivalent.  Or every 10% rise over a 6 month period signals an oncoming period of market stability and growth that will exceed 6 months.  And it doesn't have to be perfect to outperform the index, just right slightly more than half the time.

And in broad strokes I think I can buy that idea.  Recessions are not randomly distributed.  They are more likely to last between six and 18 months than between 1 and 3 months.  They don't usually happen only six months apart.  They are unlikely to last more than three years, not just empirically unlikely but fundamentally unlikely, because the US government takes steps to pull us out of recession.  They lower interest rates, they vote for stimulus plans, they start wars.  Similarly, periods of prosperity tend to engender more prosperity, because they are indicative of fertile economic ground.  The economy flourishes when we have abundant (but not too abundant) labor with the right mix of technical skills for the current marketplace, when taxes are higher, when the middle class has surplus cash to spend on discretionary items, and when resource extraction and manufacturing industries are running at full throttle.  Those things generate wealth and stability, and it takes some sort of external shock to the system to upset that period of prosperity.

So now it sounds like I'm defending dual momentum investing.  I'm just trying to hypothesize what types of underlying economic forces might cause the future market to behave in predictable patterns, and government intervention in the markets is one possibility.  Government works hard to keep the economy humming, so when the economy falters they tend to step in with proposed remedies, and the timescale of that intervention is not totally random.  It takes a few months for policies to be drafted or laws to get passed and implemented.  It takes a few more months for any effect of those changes to become evident.   Maybe the net results is that recessions will never last more than 12 months ever again?

I'm certainly not going to trade on that assumption, but it is an assumption one could build a "technical trading" system around and that system might look a lot like dual momentum. 


arebelspy

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Re: Dual Momentum Investing
« Reply #244 on: April 27, 2015, 03:09:45 PM »
First of all: chill out, miles.  No one's attacking you personally, so you don't need to get so aggressive. We're all friends here.  :)

ARS.

With all due respect I'm calling bullshit on this premise.  And I will write an entire blog post on the falseness of your premise that people choose indexing because it has a convincing story, a priori.  You are fooling yourself IMO.

Make sure you get your story straight before you waste any time.  I never claimed people choose indexing "because it has a convincing story."


People choose indexing for the same reason they choose any strategy.  Because they think it will provide superior results, BASED ON PAST DATA.  (WHich is a smart conclusion pased on PAST DATA.)

If you think I'm a fan of indexing solely because it's backtested well, you're the one fooling yourself.  If that's the only reason why you like indexing, you may want to read further on why indexing works.

I like indexing because I want the average returns of the market and the lowest fees.  That is rational reasoning for a logical strategy. If it backtests well over a certain timeframe, great.  If it doesn't, fine.  The past data is not what is convincing about indexing, to me. The rationale is.

There is value in robustness testing a strategy with out of sample testing.  There is value in seeing if an anomaly persists AFTER it is described.

Absolutely there is.  But testing a strategy that logically should work > coming up with a strategy based on testing, and having no logical reason for why it works. 

If you don't see the value in this, then you don't really understand the scientific method of testing ones hypotheses.

You need a hypothesis to test, first.  I haven't yet heard one. That's what we've been asking for.

Index funds' hypothesis would go something like: since you're unlikely to beat the market, taking the average of the market minus the least amount of fees possible will maximize your returns.  Then feel free to test that hypothesis.

What is the hypothesis of dual momentum?  As I understand it: Assets that have done well will continue to do so, and vice-versa.  Okay, now: why?

Without the hypothesis, with just the sample testing, and describing an anomaly, and then seeing if it continues to persist, you have the Tuesday/Thursday problem.

It seems apparent though by your response that you don't have an answer though.  It's what I had figured after a few pages of this thread, but still disappointing.
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Re: Dual Momentum Investing
« Reply #245 on: April 27, 2015, 03:10:44 PM »
With all due respect I'm calling bullshit on this premise.  And I will write an entire blog post on the falseness of your premise that people choose indexing because it has a convincing story, a priori.  You are fooling yourself IMO.

People choose indexing for the same reason they choose any strategy.  Because they think it will provide superior results, BASED ON PAST DATA.  (WHich is a smart conclusion pased on PAST DATA.) All of the efficient market talk is post facto attribution events that have already transpired.

The reason people choose indexing is irrelevant.  Let's just assume for the sake of argument that you are correct that people choose indexing solely because it worked in the past.  That doesn't change the fact that there are logical, a priori reasons to explain why indexing should continue to work in the future.

All we are asking is for you to explain why dual momentum should continue to work in the future.  And the answer to that question cannot be "because it worked in the past," no more than that answer could be used to explain why a 7th-Tuesday-like investment strategy that happened to work in the past will continue to work in the future.

You are incorrect in your statement about the scientific method.  If you use backtesting alone, you have proven nothing more than the fact that the strategy has worked in the past.  It is textbook survivorship bias to draw a conclusion solely from backtesting, because you are ignoring the infinite number of conceivable and backtestable strategies that failed to work in the past.  If you backtest enough strategies, you are bound to find one that worked through random chance alone.

And to Sol's and Rebs' point, in this five-page-and-counting thread, the dearth of discussion regarding the logic behind this strategy, despite the fact that we keep asking about it, seems telling.

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Re: Dual Momentum Investing
« Reply #246 on: April 27, 2015, 03:11:20 PM »
Can you answer why a dual momentum strategy should work going forward without using any previous historical data or saying "it empirically has worked" or anything like that?

I have some vague answers for that question.  I don't generally ask people for answers without having some idea of what I might expect in response.

...[vague answers to that question]...

Right.  Like I said earlier, it seems to be dependent on people being rational in their irrationality.  I also am not convinced that's worth betting on.
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sol

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Re: Dual Momentum Investing
« Reply #247 on: April 27, 2015, 03:21:10 PM »
With all due respect I'm calling bullshit on this premise.  And I will write an entire blog post on the falseness of your premise that people choose indexing because it has a convincing story, a priori.  You are fooling yourself IMO.

People choose indexing for the same reason they choose any strategy.  Because they think it will provide superior results, BASED ON PAST DATA. 

I think you've misunderstood, miles.  People don't choose indexing because it backtests well against an index.  They choose indexing because they want to get market returns, good or bad, without taking on any additional risk by trying to beat the system.  I choose indexing because I'm prepared to play the game straight and accept average returns the same as everyone else is getting, at the lowest cost to me.  I'm not trying to win at anyone else's expense.

Quote
I've already given you my post facto attribution for why I believe momentum has worked and will continue to work.  Because human investors and institutions chase performance. 

Performance chasers exist, but that doesn't tell you anything at all about how to devise a momentum strategy.  What part "performance chasers exist" determines your lookback period?

I'm not arguing that performance chasers don't exist.  I'm arguing that your strategy is really about the timing and duration of those otherwise random motions.  And I'm still waiting for your explanation as to why, say, a 6 month lookback period gives you a more useful signal than a 3 or a 12 month lookback period.  A reason that is not "I shook up all the answers and this one came out on top" because that is just as easily attributable to random chance as market foresight. 

There is always going to be SOME technical trading strategy that backtests better than all of the others for any given period.  Historically, the winning strategy tends to change every few years.  Why should we believe that this one will continue to outperform?

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with your own personal vision for how the market works is solipsistic.

You've really got to tone down the personal attacks, man.  It's kind of been your theme in this thread.  Remember to attack the argument, not the person making it.

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see the value in this, then you don't really understand the scientific method of testing ones hypotheses.

I have a bunch of letters after my name that suggest I understand the scientific method better than most people.  To follow your lead here, what's your null hypothesis?  What useful insight can you extract from that?  Surely you already know that you can never test a hypothesis using existing data if you've used that data to generate the hypothesis, right?
« Last Edit: April 27, 2015, 03:23:27 PM by sol »

hodedofome

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Re: Dual Momentum Investing
« Reply #248 on: April 27, 2015, 03:31:55 PM »
For the love arebelspy, brooklynguy, sol, forummm. Would ya'll read my links before you post anymore on this thread? Just about all the information is in there to answer your questions. I'm really tired of doing your research for you.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2435323

Momentum is the phenomenon that securities which have performed well relative to peers (winners) on average continue to outperform, and securities that have performed relatively poorly (losers) tend to continue to underperform.2
The existence of momentum is a well-established empirical fact. The return premium is evident in 212 years (yes, this is not a typo, two hundred and twelve years of data from 1801 to 2012) of U.S. equity data,3 dating back to the Victorian age in U.K equity data,4 in over 20 years of out-of-sample evidence from its original discovery, in 40 other countries, and in more than a dozen other asset classes.5 Some of this evidence predates academic research in financial economics, suggesting that the momentum premium has been a part of markets since their very existence, well before researchers studied them as a science.
However, as momentum strategies have grown in popularity, so have myths around them. Some of the most common myths are that momentum is too “small and sporadic” a factor, works mostly on the short-side, works well only among small stocks and doesn’t survive trading costs. Furthermore, some argue that momentum is best used as a "screen", not as a regular factor in an investment process. Others will go so far as to say that momentum investing is like a game of “hot potato”, implying that it isn’t a serious investment strategy, with no theory or reasonable explanation to back it up.
Frankly, we’re a little irked (if that was not clear) by those who should know better but continue to repeat these myths, stretching the limits of credulity. In this essay we address and refute these myths using academic papers (that have been widely circulated throughout the academic and practitioner communities, have been presented and debated at top-level academic seminars and conferences, and have been published in peer-reviewed journals) and the simplest data taken from Kenneth French’s publicly available website, a standard dataset used by both academics and practitioners. Anyone repeating these myths, in any dimension, after reading this piece is simply ignoring the facts.


Myth #10: There is no theory behind momentum.
One of the myths often said about momentum is that “it has no theory” as those, for instance, who dismiss it as a “hot potato” strategy imply. This is false. Like other robust return premia, such as size and value, there is much debate regarding the explanation behind momentum, and again, like size and value, none of the models are so compelling that a consensus exists on their explanation. Still, there are several reasonable theories.
Most theories fall into one of two categories: risk-based and behavioral. While the jury is still out on which of these explanations better fit the data, the same can also be said for the size and value premia.
The behavioral models typically explain momentum as either an underreaction or delayed overreaction phenomenon (it is of course possible that both occur, making it harder to empirically sort things out). In the case of underreaction, the idea is that information travels slowly into prices for a variety of reasons (e.g., investors being too conservative, being inattentive, facing liquidity issues, or displaying the disposition effect—the tendency to sell winners too quickly and hold onto losers too long). In the case of overreaction, investors may chase returns, providing a feedback mechanism that drives prices even higher.26
The other possibility is that the momentum premium is compensation for risk. One set of models argues that economic risks that affect firm investment and growth rates can impact the long-term cash flows and dividends of the firm that generate momentum patterns. The idea is that high-momentum stocks face greater cash flow risk because of their growth prospects or face greater discount rate risk because of their investment opportunities, causing them to face a higher cost of capital.27 In addition, others argue that the presence of a correlation structure across markets and asset classes of momentum strategies is indicative of a shared economic risk.28
While academics debate whether risk or behavioral explanations matter more, for the practical investor the distinction is far less relevant. Why? Because both the risk and non-risk based explanations provide an economic reason for the premium to exist and, importantly, persist.
From a risk-based perspective, as long as risks and tastes for risks don't change, the premium will remain stable and long-lived. Likewise, under the behavioral explanations, as long as the biases, behaviors and limits to arbitrage remain stable, the premium will as well. The evidence from over 200 years of data, in dozens of financial markets, and in many different asset classes suggests that these phenomena are not short-lived.
And remember, some of momentum’s biggest myth spreaders still want to use it in some capacity (as a “screen” or in an “ancillary” way). While we’ve already discussed this in depth, it’s important to again note this means they believe in momentum. Earlier we said “you can’t be a little pregnant” so one wonders, since these folks are clearly expecting, was the father behavioral or risk-based?
Despite all this, there are still some that say “the momentum premium is not large enough to trade profitably, because if it was it would be an example of market mispricing.” This statement seems to be based mostly on religion rather than fact. The idea is that if the momentum premium is really as large and robust as we show it to be, then it must be due to a market inefficiency and therefore (and here’s where the religion comes in) it can’t be real, as markets are obviously perfectly efficient. This thinking implies that if markets are efficient, then the data on momentum must be wrong. While we believe risk-based efficient market explanations play an important part in all of these factors’ returns, we also believe there is a role in each, perhaps at different degrees, for behavioral explanations. Some believe it’s all one or the other.29 But, even if you believe that, the statement “what you’re saying can’t possibly be true despite the overwhelming evidence or my one-sided view of the world would be wrong” is not an argument but a tacit admission of defeat!
There are two alarming things with this myth. First, the data are undeniable, and (as history has shown repeatedly) rejecting data on the basis of theory can be dangerous (cf. Christopher Columbus 1492, Galileo Galilei 1615, and Salem Massachusetts 1692). Second, the statement denies any possible efficient markets stories for momentum, which, as discussed above, do indeed exist (and is ironic coming from the efficient-markets-only crowd).
Most importantly, while we can debate forever how efficient or inefficient markets are (indeed, the Nobel Prize committee this year couldn’t decide and split the prize between the two camps), none of this debate should diminish momentum as a valuable investment tool. The point is not to confuse the theoretical debate (which is ongoing, not just for momentum, but for other premia, like value, as well) with the empirical consensus on the efficacy of momentum. We discovered the world wasn’t flat before we understood and agreed why.


hodedofome

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Re: Dual Momentum Investing
« Reply #249 on: April 27, 2015, 03:36:30 PM »

Performance chasers exist, but that doesn't tell you anything at all about how to devise a momentum strategy.  What part "performance chasers exist" determines your lookback period?

I'm not arguing that performance chasers don't exist.  I'm arguing that your strategy is really about the timing and duration of those otherwise random motions.  And I'm still waiting for your explanation as to why, say, a 6 month lookback period gives you a more useful signal than a 3 or a 12 month lookback period.  A reason that is not "I shook up all the answers and this one came out on top" because that is just as easily attributable to random chance as market foresight. 

There is always going to be SOME technical trading strategy that backtests better than all of the others for any given period.  Historically, the winning strategy tends to change every few years.  Why should we believe that this one will continue to outperform?

Don't think you saw my screenshot of data showing different timing lookback lengths above. All performed well, didn't matter which one you chose. All of this came from links I provided before, which you obviously didn't read.