What Is Dual Momentum Investing?

Dual momentum is a popular investment strategy among traders because it takes the fundamentals of momentum investing and hones it into an even more effective approach. But what does this strategy target? It looks out for equities experiencing price uptrends on both a relative and absolute basis.

In this guide, we’ll discuss dual momentum investing, including how it’s better than traditional momentum investing, its pros and cons, and its history. We’ll also review an example to illustrate the concept.

What is traditional momentum investing?

The thinking behind traditional momentum investing is fairly straightforward. 

In practice, this is how momentum investing works: A trader leverages momentum indicators, or metrics used to track stock performance, to search for and eliminate assets and asset classes experiencing strong relative momentum in the form of rising prices. They can be in any industry or vertical the trader wants, as long as the technicals show that price uptrend. Then, after initiating the trade, the trader closely watches the holding’s price until the trend reverses and the price drops. That’s when they sell it close to the top before the drawdown, rebalancing as needed until they meet their trade criteria.

As a trading strategy, momentum investing can be highly profitable, particularly during stock market volatility and bull markets, enabling savvy investors to stack up impressive returns that outperform the overall market in total return. But it’s not perfect. 

Traditional momentum strategies can lead to a lot of trade turnover, resulting in high transaction costs. Ideally, trading profits should offset these costs, but no trader wants to take an extra expense they don’t need to.

Challenges of traditional momentum investing

The momentum model can be effective, but there are a few shortcomings, including tax inefficiencies, high trade turnover, large drawdowns, and costs related to the ongoing need to rebalance the portfolio. And this is where dual momentum investing can help. 

Understanding dual momentum investing

Dual momentum investing offers a twist on standard momentum investing by combining relative strength price momentum with trend following absolute momentum and reducing the amount of trade activity needed to reach a positive result.

Simply put, dual momentum strategies select stronger assets on a relative and absolute basis that deliver greater outperformance than those stocks and exchange-traded funds (ETFs) that typical momentum investors target.

Gary Antonacci first introduced it in the 2014 book, “Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk.”

The momentum indicators used in these types of trading strategies are rooted in the technical trading data of stocks and ETFs.

Common momentum indicators include:

• Price change of a given stock over a predetermined period

• Rate of change (ROC)

• Relative strength index (RSI), which considers the speed and magnitude of an asset’s price changes to determine if the stock is overbought or oversold

• Moving average convergence/divergence (MACD), which uses the divergence between two moving averages of a security’s price to deliver trading signals

• Stochastic oscillator, a momentum indicator that calculates pricing divergence over time based on closing prices.

Most momentum investors base their trades on one or two of these momentum indicators at a time, while dual momentum investing adds additional angles to the decision-making process. It’s a strategy focused on choosing assets that have both historically outperformed the overall market and generated a positive absolute return.

The origins of dual momentum investing

In his book, Antonacci says, “Perhaps the best-known investment paradigm is buy low, sell high. I believe that more money can be made by buying high and selling at even higher prices […]. I try to buy stocks that have already had good price moves, that are already making new highs, and that have positive relative strength […]. I always look for the best potential performance at the current time. Even if I think that a stock I hold will go higher, if I believe another stock will do significantly better in the interim, I will switch.” 

While Antonacci gets the credit for introducing the trading public to dual momentum investing, momentum as an investment concept and strategy had been around for nearly a century when his book came out. Traders as far back as the ’20s already used the principles of momentum to rate different stocks based on the understanding that the top-performing assets from a given year were statistically more likely to continue posting strong returns the following year.

Antonacci’s twist on momentum investing was designed to tap the advantages of relative and absolute momentum (more on this in a bit) to give traders the best of both worlds while protecting their portfolios from risk. He did this (and his book offers dozens of specific examples of structuring these trades) by first using relative momentum indicators to find the best-performing assets. Then, he used absolute momentum as a trend-following filter to zero in on those momentum stocks showing positive strength, regardless of what’s happening with their peers.

These two data points ensure that every trade follows the overall market trend.

“In addition to relative strength momentum, in which an asset's performance relative to its peers predicts its future relative performance, momentum also works well on an absolute or time series basis in which an asset's own past return predicts its future performance,” Antonacci says. “In absolute momentum, we look only at an asset's excess return over a given look-back period. In absolute momentum, there is significant positive auto-covariance between an asset's return in the following month and its past one-year excess return. Absolute momentum is, therefore, trend following by nature.”

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How do absolute momentum and relative momentum work?

Every stock is part of the overall U.S. stock market, but they also exist relative to their peers, similarly priced assets, and other comparables. 

Relative momentum, or relative strength, compares the prices of two assets over a set period—the stock or ETF with the better return has positive relative momentum than the other.

In dual momentum strategies, traders use this as the first filter when choosing the asset classes or stocks they want to invest in.

From there, absolute momentum looks at each asset’s performance without comparing it to others. For example, it answers questions like how its price has changed, or which trend it’s experiencing over the last weeks, months, and quarters. If the overall return is positive, the asset has positive absolute momentum. In contrast, if the price has been declining, the absolute momentum is negative.

Dual momentum traders move forward only with positive relative and absolute momentum assets. The idea behind this strategy is that although a stock can have both positive and negative momentum traits simultaneously, nobody would want to invest in that stock because this introduces risk to the overall trade and increases transaction costs.

For example, a stock in the middle of a bear market might have positive relative momentum versus the overall down market, but that doesn’t change the fact that its absolute momentum is negative, as is its overall outlook as an investment. The flip side is also true. Even if a stock has positive absolute momentum, if it is a laggard in its segment and has negative relative momentum, it indicates that better options are available for trade.

A dual momentum investing strategy emphasizes better decision-making by incorporating both forms of momentum that impact asset prices.

Pros and cons of dual momentum investing

While analyzing absolute momentum over a set look-back period requires little more than pricing data and the right momentum indicator for the target security, relative momentum analysis can benefit from using ETFs that cover broader markets.

For example, State Street Global Advisors’ SPDR (SPY) offers a snapshot of the entire S&P 500 index that traders can leverage using their momentum indicators to determine an asset’s relative strength compared to the stock market as a whole (the returns of a broad market index fund could provide such information as well).

The same applies to Vanguard’s Total Bond Market ETF (BND) for analyzing the bond market and Vanguard's Total International Stock ETF (VXUS) for international equities.

Dual momentum investing has been praised for its effectiveness and simplicity, but understanding both its advantages and limitations is crucial. Here are a few pros and cons:

Pros

More cost savings

Dual momentum traders can reduce their overall transaction costs and trading fees by decreasing the number of trades involved in the strategy.

Fewer drawdowns

Traditional momentum investing strategies mean the trade ends when the pricing uptrend reverses. By incorporating both relative and absolute momentum in their targets, dual momentum traders look to invest in solid uptrends with more staying power in the hopes of reducing maximum drawdowns.

Eliminates trading biases

Like all technical trading strategies, dual momentum investing is a trend-based approach that ignores the fundamentals behind the asset, enabling traders to focus solely on pricing trends when making decisions.

Cons

Pre-trade research

Every momentum trading strategy, including dual momentum, requires traders to complete extensive pre-trade research and analysis to find target equities and plan an exit strategy.

Active management

Investors must actively monitor their dual momentum investing strategies throughout the trade to spot the trend reversal and initiate the exit.

What is an example of a dual momentum strategy?

To illustrate the dual momentum strategy in action, let's consider a practical scenario involving the technology sector and Apple Inc. as a specific stock.

Scenario: An investor seeks a strategy to optimize their investments within the technology sector while reducing risk. They decide to apply a dual momentum approach.

Step 1: Sector selection (relative momentum) 

The investor begins by assessing the relative momentum of various sectors in the stock market, including technology, healthcare, and consumer goods. They analyze the past 12 months' performance of these sectors.

After careful evaluation, they notice that the technology sector has consistently outperformed the other sectors in terms of price appreciation over this period. This strong relative momentum makes the technology sector an attractive choice.

Step 2: Stock selection (absolute momentum) 

Now that the investor has chosen the technology sector, they focus on individual stocks, with Apple Inc. being one of their options. They employ absolute momentum analysis by examining the historical price trends of Apple's stock over the past six months. 

After thorough analysis, they identify Apple Inc. as a stock with sustained upward momentum during this time frame. Its positive absolute momentum aligns with the criteria for stock selection.

Conclusion: By combining relative momentum for sector selection (favoring the technology sector) and absolute momentum for stock picking (choosing Apple Inc.), the investor constructs a portfolio to capture assets with strong performance indicators. This dual momentum strategy allows them to adapt to changing market conditions, gives them access to market timing, and helps them focus on investments showing both relative strength within their sector and consistent upward price trends.

Dual momentum investing with Composer

Searching for a platform that can help you with investment management and research? Look no further than Composer. We make your investing experience less arduous by automating much of the research and monitoring that goes into portfolio management. Rather than running momentum indicators manually on an ongoing basis, automated management analyzes trades in real time, making trades when indicators flag a trend reversal.

In addition, Composer’s backtesting tool includes fees and slippage in its pricing analysis to help you understand the tradeoff between trading costs and the benefits of responsive strategies. 

Head to composer.trade, and start your free 14-day trial today.