The financial and betting markets operate in the same manner. They both take analysis and information, both hard and soft, and translate it into an ever changing price that reflects the supply and demand for that particular horse, share, bond or commodity.
It is perhaps the market for small company shares that most closely resembles the horse racing markets. This is because it is very possible for someone who specialises in small companies to get themselves an “edge” over the general market via an original modus operandi. In horse racing we use sectional time analysis, first hand inside information, and, understanding how dosage affects a horse’s performance/stamina. The most successful small-cap investors use detailed analysis, visit shareholder meetings and get to know the CEO’s and CFO’s who exert huge influences on smaller companies. In short, they do stuff that the rest of the marketplace doesn’t do, and hence they have an “edge”.
However, my personal approach to investment is far more simple and based upon investor psychology and hundreds of years of investment research. I invest/trade systematically and am a “trend-follower” or “momentum investor”. If any of you want to read background on this approach then there are a number of excellent books, a few of which I have referenced at the bottom of this article.
The majority of the most successful long-term investors have been systematic traders/investors. The emphasis is on “long-term”. The methodology I use has credible results going back to the 1950’s and theoretical results going back over a much longer period than that. I was introduced to the methodology back in the late 1980’s when reading about “The Turtles” and a man called Richard Dennis. In brief, Richard recruited a group of people (subsequently nicknamed the “turtles”) in an experiment to see if they could be taught how to trade successfully using a few simple, systematic rules. Many of that original group went on to be very successful investment managers. The systems they used were systematic trend-following.
In it’s simplest form, trend-following is buying something when it is in a positive upward trend and selling it when that trend reverses. This means you can capture upward momentum and avoid downward momentum. How you measure such momentum is, I suppose, the “secret sauce”. Different investors use different measurements of momentum. These can be things such as moving averages, exponential moving averages, price breakouts, Bollinger bands, Donchian channels and all other manner of bewildering numbers. But the reality is, if the methodology is sound (and it is) then a simple measurement of momentum is all that is required. It should obviously be optimised (fine tuned) but not to the point that you are indulging in back-fitting, as that is the quickest way to the poor house. Read good literature on the subject and don’t waste time looking for the “magic numbers”……they don’t exist!
I use two measurements of momentum, absolute momentum and relative momentum. Absolute momentum measures the investment against it’s own performance. Relative momentum measure the investment against the performance of other investments. Both are simple measurements that take me seconds to find on any good broker site (I use Hargreaves Lansdown).
I look at the Absolute Momentum figure for my “portfolio” of investments (shares, bonds, commodities with a good geographical spread) and then choose the top 4 (it could easily be 5 or 6 or 7….but 4 just suits me) providing there are 4 with positive absolute momentum and invest in those. The top 4 obviously have the highest relative momentum.
Here is my year to date….starting with a notional £1,000,000 to invest.
On Jan 1st (it was actually 28th December)…only 2 of my funds had positive Absolute Momentum, UK Gilts and Food/Agriculture. So;
250,000 UK Gilts
On Feb 1st a profit of + 4,775
254,300 UK Gilts
250,000 Index Linked Gilts
250,000 Global Bond
Both of the funds had been positive returns and two new funds entered the top 4 (Index Linked Gilts and Global Bond Fund).
On 1st March a profit of +5273 (running total +10,048)
255,571 UK Gilts
252,000 Index Linked Gilts…..now sold and 252,000 bought of Global Energy
250,750 Global Bond……now sold and 250,750 bought of Gold
Although both Index-Linked Gilts and Global Bond funds had made money, they were then replaced by Global Energy and Gold who both had positive absolute momentum and higher relative momentum than the funds they replaced.
On 1st April a profit of +24,717 (running total +34,765)
262,139 UK Gilts…now sold and replaced by US Shares
258,199 Global Energy
UK Gilts fund still had positive absolute momentum but was overtaken by the relative momentum of US Shares.
On 1st May a profit of +19,474 (running total of +54,239)
276,478 US Shares
239,290 Gold……now sold and replaced by Emerging Markets Shares
268,423 Global Energy….now sold and replaced by Index Linked Gilts
Gold registered big losses for me here, but it was made up for in profits on the other investments. Gold is replaced and so is Global Energy (although positive, it had slipped behind Index Linked Gilts). Also, as I now have quite a discrepancy between the 239,290 in the Emerging Markets fund and 268,423 in the Index-Linked fund, I balanced these two funds out to have 253,856 each.
On 1st June a Loss of -5,976 (running total of +48,262)
274,625 US Shares
241,366 Emerging Markets….now sold and UK Gilts bought
264,949 Index Linked Gilts
Losses in all of the funds except for Index-Linked Gilts. However, US Shares and Food/Agric remain with positive absolute momentum and in the top 4 of relative momentum. Only Emerging Markets are replaced.
On 1st July a profit of +17,342 (running total of +65,604)
283,563 US Shares
243,756 UK Gilts, now sold and Gold bought
266,740 Index Linked Gilts
A good month with profits in all 4 funds. However, the relative momentum of Gold pushes into the top 4 ahead of UK Gilts.
On 1st August a profit of +50,259 (running total of +115,863)
296,076 US Shares
270,322 Index Linked Gilts
A phenomenal month with Gold being the star performer. All funds retained their place in the top 4.
On 1st September a profit of +41,372 (running total of +157,235)
295,661 US Shares
278,384 Food/Agric….now sold and replaced by UK Gilts
290,920 Index Linked Gilts
Another excellent month with Gold and Index Linked Gilts producing huge retruns. Food/Agriculture is finally replaced by UK Gilts after being in the portfolio all year.
This coming month’s 4 look quite defensive with Gold and 2 Gilt funds alongside US Shares. The key to successfully trading like this however is to forget all the analysis and believe in the system, which has been tested right back to the 1950’s.
Absolute Momentum ensures you get out of funds that are in a negative downtrend. The drawdowns of this type of system are half of what you would experience with a simple “buy and hold” strategy that the financial media pushes.
Relative momentum ensures you are onside with funds that are on a roll. You will never buy at the bottom and you will never sell at the top…..but you will sleep well!
Trend Following by Michael Covel
Dual Momentum by Gary Antonacci