Alpha Momentum Strategy - Portfolio Report – April 2018 – First Half

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Despite the recent selloff in US equities, as per The Alpha Momentum Strategy, both the long and intermediate trends in US stocks are up. As such, the model portfolio will remain 100% invested at least through the first half of the month of April. We will be executing trades such that the model portfolio reflects the following composition as of close of trade tomorrow, April 3rd, 2018.

Commentary: The Alpha Momentum Strategy is a combination of a relative momentum strategy and an absolute momentum strategy. This means that the decision of which individual stocks to hold is a function of how those stocks have performed relative to other stocks in the investment universe (relative momentum). Whether the portfolio is fully invested, partially invested, or all in cash is a function of both the market (S&P 500) and individual stocks’ positions relative to their long term trends (absolute momentum).

In trading, “whipsaws” occur when market weakness causes a system to take defensive action (reduce investments and move to cash) followed by market action whereby this weakness is subsequently reversed, leaving the trader on the sidelines while the investments he previously held move higher. Whipsaws are frustrating!

The designer of algorithmic trading systems faces the challenge of minimizing whipsaws without exposing the portfolio to large adverse swings in capital (drawdown). Unfortunately, as a trader adjusts his system such that drawdown risk decreases, whipsaw risk will increase. As a trader adjusts his system such that whipsaw risk decreases, drawdown risk increases.

With the Alpha Momentum Strategy, we have attempted to strike a balance between whipsaw risk and drawdown risk that we feel maximizes risk-adjusted returns, or the amount of return we receive for each unit of risk taken. After maximizing risk-adjusted returns, we choose to manage drawdown risk through an asset allocation decisions (e.g. “We know the maximum historical drawdown for the system is ~50%, so how much of our capital should we allocate to the system given that, historically, we would have drawn down at least 50% of that capital at one point”).

When making a decision about what percentage of the portfolio is invested versus what portion is in a defensive position (in cash), we look at both a long term trend and an intermediate trend. In order to reduce whipsaws and create a more robust system, we evaluate the long term trend at the beginning of the month, and the short term trend at the mid-point of the month (when designing the system, the exact timing of the evaluation wasn’t important, we chose these points arbitrarily. The consistent application of the rules is the most important factor here).

As such, there can be times when the short term trend is lower, but we remain fully invested, as we only evaluate the short term trend in the middle of the month. This is the case now, and should the short term trend remain lower at the mid-point of April (April 13th to be exact), the model portfolio will move to a 50% cash position as of close on April 16th.

So we have a bit of an “intellectual pickle.” Our short term trend is down, yet we remain fully invested. Does this create cause for concern? Not really – the data shows that the system as it is designed is robust and it has weathered many bear markets. The system has faced similar situations in the past. We have no reason to doubt that this time will be dramatically different. There will be volatility, but we are confident that we will be rewarded in the long term application of this system. We are confident that this strategy does a better job of compensating us for any unit of risk taken than anything else offered to the mainstream public.

Performance

We are not fans of tracking performance over very short term periods (months, quarters, half years) because too much focus on short term performance can create emotional strife and, to be frank, short term performance doesn't really tell the true performance story of a strategy. Performance should ideally be evaluated over periods of a minimum of 5 years and ideally 10+ years and many different market environments. When actual performance data isn't available, simulation data should be used for evaluation purposes, assuming simulations are done well (without bias and in an intellectually honest fashion). That said, there is something to be said about accountability and performance. Profit and loss is the ultimate accountability metric in trading and investing. As such, we will report our monthly performance here going forward.

Thanks for following along!