Stock-Strategy: Dual Momentum Rotation Strategy for S&P 500 Stocks

Momentum strategies performed well in the first quarter of 2024. The S&P 500 Dual Momentum Rotation Strategy gained 24.8% in the first three months and handily outperformed its benchmark. $SPX was up 10.2%. Breaking it down, the strategy was up 7.3% in January, 11.1% in February and 4.7% in March. S&P 500 stocks even outperformed Nasdaq 100 stocks in March.

This report has two sections. The first section covers the methodology behind the Dual Momentum Rotation Strategy. The second section covers performance metrics and these are updated at the end of every month. Click here to jump to lasted performance metrics. 

Momentum has provided a persistent edge in the US equity markets for decades. Stocks that are currently in uptrends are more likely to extend their uptrends and stocks that are outperforming now are more likely to outperform in the future. This strategy capitalizes on momentum by using two types: absolute momentum and relative momentum. First, we filter to find stocks that are in strong uptrends (absolute momentum). Second, we rank performance to select stocks that are outperforming the other index constituents. When used with a market timing filter, this dual-momentum approach outperforms buy-and-hold with significantly lower drawdowns. The signal table is covered at the end.

The usual disclaimers apply for the strategies and the analysis on TrendInvestorPro. Past performance does not guarantee future performance. You and you alone are responsible for your investment and trading decisions. Do your own due diligence.

Strategy Highlights

  • Weekly Trading
  • Market beating returns with lower drawdowns
  • Trend Filter to ensure stock is in a strong uptrend
  • Momentum rank to select the leaders
  • Market filter to preserve capital during bear markets

S&P 500 Stocks sans Financials

This strategy trades S&P 500 stocks and excludes the finance sector. The finance sector is one of the biggest sector in the S&P 500, but it is by far the weakest of the 11 sectors over the last twenty years. The PerfChart below shows 20 year performance for the 11 sector indexes. The S&P 500 Financials Index ($SPF) shows the smallest gain.

Strategy Mechanics

This is a long only strategy that trades only in bull markets. We use a 14 indicator breadth model to define bull and bear markets. The strategy moves to cash during bear markets. This market filter limits drawdowns and preserves capital during bear markets.

The trend indicators are the exponential slope over two periods. These indicators quantify trend strength and select stocks in strong uptrends (absolute momentum). They also filter out stocks that are in downtrends.

The momentum indicator measures the volatility-adjusted price change. Its purpose is to rank stocks and select the strongest stocks in the index (relative momentum). We use the prior month’s value to mitigate the propensity to buy overbought stocks.

Volatility filters exclude stocks with excessively high volatility (extreme risk) and unusually low volatility (takeover candidates).

Liquidity filters exclude low-price stocks, stocks with low volume and stocks with low Dollar-Volume (price multiplied by volume).

The strategy buys the top ten stocks and sells a position when the stock drops out of the top twenty. The replacement is the stock with the highest ranking and a stock that is not already in the portfolio.

There are two other exit signals. First, an exit signal triggers for an individual position when the trend indicator signals a downtrend. Second, all positions are closed when a bear market signals.

The rotation feature triggers sell signals in stocks that experience a decrease in relative momentum. These stocks are often still in uptrends, but relative momentum is waning. Exit signals, therefore, are not always based on a trend change or significant decline. This rotational aspect helps curtail losses because stocks are not always sold after a big drawdown. The strategy then rotates into stocks showing an increase in relative momentum.

Testing Criteria

– Performance metrics are based on backtesting with historical constituents.

– Buy and sell signals are based on closing prices at the end of the week.

– Entries and exits are based on opening prices at the beginning of the week.

– Each buy and sell includes a .10% charge to account for slippage and commission.

– Each entry position is sized to be 10% of the portfolio

– The strategy holds a maximum of ten positions.

– Returns do NOT include dividends.

– Returns do NOT include interest earned from cash.

Performance Metrics (Last Update: March 30, 2024)

The table below shows performance metrics for the strategy and $SPX buy-and-hold. The strategy outperformed buy-and-hold with a significantly higher Compound Annual Return (CAR): +14.86% vs +8.77% (green shading). Just as important, the Maximum Drawdown is less than half that of buy-and-hold and an Average Drawdown is in the 17.5% range (blue shading)

The chart below shows the equity curves for the strategy (green line) and for S&P 500 buy-and-hold (black line). The equity curve for the strategy surged in 2024 and hit a new high ($1,900,301). Overall, the strategy outperforms by tripling ending equity for $SPX buy-and-hold. Also note that $SPX buy-and-hold experienced large drawdowns in 2008 (56%) and 2020 (34%). Notice how $SPX buy-and-hold turned negative as it dipped below $100,000 in 2008. The strategy mitigated these drawdowns and preserved capital by using a market filter.

The next image shows the annual returns for the strategy. There were 3 losing years, 18 winning years and one flat year (2008). The strategy was in cash throughout 2008 because the market filter was bearish. Note that these returns do not include dividends or interested earned on cash. The average return over the entire period was 14.9% per year (blue line) and the Annual Sharpe Ratio is 1.1.

Even though the equity curve and annual returns look good, there will be drawdowns and doubts along the way. The next image shows the drawdowns over the entire period (blue line). Drawdown is the percentage decline from an equity high. The biggest drawdowns occurred in 2005 and 2011 as they reached the 18% area. The horizontal lines show the median and average drawdown.

The next image shows the monthly return breakdown for the strategy. Hashmarks (-) show when the strategy was in cash because the market filter was bearish.

Trading a strategy is a long-term endeavor, not a brief undertaking. There will be ups and downs, as well as periods of outperformance and underperformance. We cannot judge performance using days, weeks or even a few months. Long-term endeavors require a minimum of six months before passing judgement. Past performance does not guarantee future performance, but this dual-momentum strategy should keep its edge as long as the momentum edge persists in the US equity market.

The usual disclaimers apply for the strategies and the analysis on TrendInvestorPro. Past performance does not guarantee future performance. You and you alone are responsible for your investment and trading decisions. Do your own due diligence.

Summary Tables with Signals

This section covers the signal tables, which are posted every weekend. The tables for the S&P 500 and Nasdaq 100 signals work the same way. This example covers the S&P 500 signals, but the process for using the Nasdaq 100 signal table is the same.

We start with a summary table showing current positions and new entry/exit signals. The top 20 stocks for the current week and prior week are on the right (blue/yellow shading). These side-by-side tables make it easy to see when a stock falls out of the top 20.

The table shows current positions (Open Long), new ENTRIES (green) and new EXITS (red). These signals are based on the close on the last trading day of the week. This date appears at the top left of the table. The actual ENTRY and EXIT are for the first trading day of the following week.

The current ENTRY/EXIT signals also appear below this table. In the example above, there is an ENTRY signal for LLY and an EXIT signal for RSG. Not all weeks have ENTRY and EXIT signals. Sometimes the portfolio stays the same. EXIT signals trigger for three reasons: the stock falls out of the top 20, an indicator turns bearish or the CBM turns bearish.

The next table shows the last 20 closed positions. This table includes the entry date, the exit date, the percentage gain/loss and bars held. Bars represent trading days (no weekends or holidays). 20 bars is the equivalent of four weeks.

The usual disclaimers apply for the strategies and the analysis on TrendInvestorPro. Past performance does not guarantee future performance. You and you alone are responsible for your investment and trading decisions. Do your own due diligence.

Thanks for tuning in and have a great day!

-Arthur Hill, CMT
Choose a Strategy, Develop a Plan and Follow a Process

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