What Is Dual Momentum Investing
Dual momentum investing is a popular trading strategy among traders for the simple reason that it takes the fundamentals of momentum investing and hones it into an even more effective approach. The target of this strategy? Equities that are experiencing price uptrends on both a relative and absolute basis.
The thinking behind traditional momentum investing is fairly straightforward. To learn more about momentum investing, check out:
Using momentum indicators, or metrics used to track the performance of stocks, the trader searches for and isolates out those assets and asset classes that are experiencing strong relative momentum in the form of rising prices. They can be in any industry or vertical that the trader wants, as long as the technicals are showing that price uptrend. Then, after the trade has been made, the trader closely watches the price of the holding until the trend reverses and the price starts to drop. That’s when they sell, as close to the top as possible before the drawdown, rebalancing as needed until their trade criteria are met.
As a trading strategy, momentum investing can be extremely profitable, particularly in times of stock market volatility and bull markets, enabling savvy investors to stack up impressive returns that outperform the overall market in total return. But, it is 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 that they don’t truly need to.
Understanding dual momentum investing
Enter what is known as “dual momentum investing.” This strategy offers a twist on standard momentum investing by combining relative strength price momentum with trend following absolute momentum. It was first introduced by Gary Antonacci in his 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. When applied correctly, they can use the past performance of assets to determine future price moves. The list of common momentum indicators includes the Price Change of a given stock over a pre-determined period of time; the 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; and a stochastic oscillator, a momentum indicator that calculates pricing divergence over time based on closing prices. Go deeper on indicators with 5 Best Momentum Indicators for Retail Investors.
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 is a strategy that is focused on choosing assets that have both historically outperformed the overall market and also generated a positive absolute return.
To understand how that works in practice, it is first important to better understand the different types of momentum that can impact stock prices.
Absolute momentum vs. relative momentum
No stock exists in a vacuum. They are part of the overall U.S. stock market, for one thing, 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 time period — the stock or ETF with the better return has positive relative momentum vs. the other.
In dual momentum strategies, this is the first filter that traders use when choosing the asset classes or stocks they want to invest in.
From there, absolute momentum looks at the performance of each asset without comparing it to any others. How has its price been changing? What is the trend it has experienced over the last weeks, months, and quarters? If the overall return has been positive, then that asset has positive absolute momentum. If the price has been falling, then the absolute momentum is negative.
Dual momentum traders then only move forward 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, we wouldn’t want to invest in that stock because it would introduce risk to the overall trade and increase transaction costs.
For instance, a stock in the middle of a bear market might have positive relative momentum compared to the overall down market, but that does not 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, that indicates that there are better options out there for a trade.
A dual momentum investing strategy forces better decision-making by incorporating both forms of momentum that impact asset prices.
The origins of dual momentum investing
“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.” ― Gary Antonacci’s Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk
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 1920s were already using 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 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 ways to structure these trades) by first using relative momentum indicators to find the best-performing assets. Then, absolute momentum is used as a trend-following filter to zero in on those momentum stocks that are showing positive strength on their own, regardless of what is happening with their peers.
These two data points ensure that any trade follows the overall market trend.
Antonacci wrote in 2014:
“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. 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.”
The challenges of traditional momentum investing
Although the momentum model can be effective, there are shortcomings, including tax inefficiencies, high trade turnover, large drawdowns, and costs related to the ongoing need to rebalance the portfolio. Dual momentum investing was created to address these challenges, and it does it mainly by reducing the amount of trade activity needed to reach a positive result.
Simply put: dual momentum strategies are designed to select stronger assets on a relative and absolute basis that deliver greater outperformance than those stocks and ETFs that typical momentum investors target. With market conditions being equal, asset allocation using Antonacci’s dual momentum approach has performed better than buy-and-hold benchmarks.
Or at least that’s the idea.
On the whole, dual momentum simplifies the trend sorting process. When the market appreciates, traders want to invest in the best-performing assets on the market. The opposite is true when a bear market takes over, and traders want to sell off the worst-performing assets. And, by isolating the best of the best and the worst of the worst, dual momentum investing makes it easier for traders to identify stocks and ETFs that meet these criteria.
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 exchange-traded funds (ETFs) that cover broader markets.
For instance, 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 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.
Pros of dual momentum investing:
By reducing the number of trades involved in the strategy, dual momentum traders can reduce their overall transaction costs and trading fees.
Traditional momentum investing strategies are based on the idea that 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.
Eliminate 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 of dual momentum investing:
Every momentum trading strategy, including dual momentum, requires that the trader complete extensive pre-trade research and analysis to find target equities and plan an exit strategy.
Dual momentum investing strategies must be actively monitored throughout the trade to spot the trend reversal and initiate the exit.
Dual momentum investing with Composer
That said, Composer is helping to make those cons less arduous for traders 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 investors understand the tradeoff between trading costs and the benefits of responsive strategies.
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