Wednesday, July 22, 2015

Risk control strategy vs. absolute momentum

I've made some research trying to find out if the absolute momentum strategy can produce better Sharpe than simple buy & hold. Actually, I'm a big fan of risk control strategy (portfolio rebalancing to local volatility), so my real purpose was - can I make things even better, applying absolute momentum overlay over risk control strategy?

I can't say I tested every stock in the universe. My main focus at the moment is low-beta, stable stocks and I tested them. And I can't say I've been especially creative with momentum rules. I used those: position is multiplied by k = (price - low) / (high - low), where high and low are respectively highest and lowest prices in a 9-12 month rolling window.

Absolute momentum makes Sharpe better for S&P 500 index. Well, that was the only case I found where absolute momentum increases Sharpe. Maybe somewhere in high-beta there is a point of using absolute momentum, I don't know. For all low-beta stocks that I've tested it makes Sharpe worse. At the other hand, the risk control strategy makes Sharpe better everywhere. And when you apply absolute momentum over risk control, no magic happens, things also go worse.

So, to sum up: if you use risk control strategy over low-beta stocks, absolute momentum can do nothing for you, just be happy with what you have.

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