Dual Momentum

Dual Momentum is an investment strategy popularized by Gary Antonacci, involving two types of momentum: absolute momentum and relative momentum. The strategy aims to identify superior investments by looking at the performance of assets over a specified time period and making buy/sell decisions based on comparative and absolute returns. This approach attempts to capture the benefits of both trend-following (absolute momentum) and value investing (relative momentum) strategies.

The Basics of Momentum

Momentum in finance refers to the tendency for assets that have performed well in the past to continue performing well in the future. Conversely, assets that have performed poorly are likely to continue underperforming. Momentum is generally divided into two types:

Absolute Momentum: This measures the performance of an asset relative to its own past performance. For example, if a stock has shown positive returns over the past year, it has positive absolute momentum.
Relative Momentum: This measures the performance of an asset relative to other assets. For example, if a stock has outperformed other stocks over the same period, it has positive relative momentum.

Dual Momentum integrates these two concepts to create a robust trading strategy.

Absolute Momentum

Absolute momentum is also known as time-series momentum. It focuses on an asset’s price behavior over a particular time window. Gary Antonacci recommended a 12-month look-back period for calculating absolute momentum. The procedure is straightforward:

Calculate the asset’s returns over the past 12 months.
If the returns are positive, the asset has positive absolute momentum; otherwise, it has negative absolute momentum.

Absolute momentum helps avoid investments in down-trending assets and drives the strategy to favor assets with upward price trends.

Relative Momentum

Relative momentum evaluates the performance of an asset in relation to a group of other assets. This approach allows investors to pick securities that are expected to outperform their peers. For instance, if you’re comparing multiple stocks, relative momentum would help you identify which stocks are doing better relative to the others.

The calculation typically involves:

Comparing the 12-month performance of each asset in a specified universe.
Ranking the assets based on their performance.

In the simplest form, you might always choose to invest in the top-performing assets in the group while avoiding or shorting the underperformers.

Combining Absolute and Relative Momentum

Dual Momentum strategy involves a two-step process to identify optimal investments. Here’s a generalized framework:

Step 1: Apply Relative Momentum Screening
- Identify a set of potential assets (e.g., stocks, bonds, commodities).
- Calculate the past 12-month returns for each asset.
- Rank the assets based on their returns.
- Select the top-performing assets.
Step 2: Apply Absolute Momentum Verification
- For each selected asset from Step 1, evaluate its absolute momentum.
- Measure its 12-month return.
- If the return is positive, the asset is selected for investment. If not, it is excluded or another asset meeting these criteria is chosen.

Example: Global Equity and Bond Portfolio

Let’s illustrate Dual Momentum with an example:

Asset Universe: Consider a simple universe comprising global equities and bonds.
Relative Momentum Screening: Rank the global equities and bonds based on their 12-month returns.
Absolute Momentum Verification: From the top-ranked asset(s), check if their 12-month return is positive.
- If positive, invest in those assets.
- If negative, move to the next ranked asset or allocate funds differently (e.g., to cash or Treasury bills).

This combination creates a diversified portfolio that aims to capture high-return opportunities while mitigating risk by avoiding down-trending assets.

Practical Implementation and Tools

Software and Platforms

AlgoTrader: AlgoTrader is a comprehensive trading platform that can assist in implementing Dual Momentum strategies. It offers tools for backtesting, strategy development, and live trading. Visit AlgoTrader
Python Libraries: Utilizing Python libraries like pandas and numpy can help build custom Dual Momentum models. Tools like Jupyter Notebooks provide an interactive environment to visualize and tweak the strategy.
Online Brokers: Many online brokerage platforms, such as Interactive Brokers, offer APIs for automated trading. Integrating these with Dual Momentum strategies can streamline the investment process. Visit Interactive Brokers
QuantConnect: QuantConnect is a cloud-based algorithmic trading platform allowing users to design, backtest, and deploy trading strategies, including Dual Momentum. Visit QuantConnect

Strategy Execution

Backtesting: Before deploying a Dual Momentum strategy, rigorous backtesting is crucial. This involves running the strategy through historical data to evaluate its performance. Ensure to include transaction costs and slippage in these analyses.
Live Trading: After successful backtesting, the move to live trading should be gradual. Start with a small fraction of the portfolio to monitor real-world performance.
Periodic Review: Continuously review the strategy’s performance. Markets evolve, and strategies may need recalibration over time.

Advantages and Disadvantages

Advantages

Risk Management: By combining absolute and relative momentum, the strategy can help avoid prolonged downtrending assets, thus managing risk better than simpler strategies.
Diversification: The method encourages investing across a diverse set of assets, potentially smoothing out volatility.
Systematic Approach: Dual Momentum is rule-based, reducing emotional biases in investment decisions.

Disadvantages

Data-intensive: Requires access to historical price data and regular updates, making it resource-intensive.
Complexity: More complex than single-momentum strategies, making it harder for newcomers to implement effectively.
Market Conditions: Performance can vary based on market conditions. In extremely volatile or trending markets, the strategy might not perform as expected.

Real-world Performance

Empirical studies and real-world implementations have shown that Dual Momentum strategies can outperform conventional buy-and-hold strategies over long periods. Gary Antonacci’s book, “Dual Momentum Investing”, provides ample evidence and case studies demonstrating the efficacy of the method. However, as with all strategies, past performance is not indicative of future results.

Conclusion

Dual Momentum investing offers a balanced approach to capitalizing on the inherent trends and relative strengths of different assets. By integrating both absolute and relative momentum, investors can systematically enhance returns while managing risk. Though not without challenges, the strategy’s evidence-based framework and systematic nature make it a compelling choice for both individual and institutional investors. For those willing to invest the necessary time and resources, Dual Momentum can be a potent addition to the investment toolkit.