Mr Bear,
I like this type of trading. I have done a bit of work on rotational trading systems using momentum. They work really well on small caps even with 12 month minium holds, but give big drawdowns. This is because during down markets these 'overbought' type stocks get hammered. So I see you are using the value momentum effect. Hopefully the value part helps with the DD.
I've also a lot of experience with
www.portfolio123.com where you can test these value momentum factors ad nauseam on the US market. No reatil equivalent exists for our market.
So I am following closely.
PS Are you using a screener for the fundamentals?
The Australian small cap market shows a momentum effect that I haven’t been able to replicate in other markets except Korea. This is for both pure momentum and my model of value and momentum. This isn’t to say other markets aren’t significantly profitable it’s just that Australia consistently outperforms.
My model is primarily a value model, the current universe is 60 stocks, the average return on the universe is 40%. You would do very well by taking the 6 cheapest stocks, these are all very cheap on a conservative DCF model.
I expect and know from experience drawdowns will be few but can be large, when you forecast for so many stocks and take into account fraudulent CEO’s a downgrade on even a cheap stock can be huge, this has nothing to do with buying a momentum stock.
Blue Sky for example was in my universe, didn’t buy it but look what happened.
Adding momentum however combines two things, stocks I think are cheap with stocks that cleary fund managers think are cheap. I want to be buying cheap stocks that instos are driving up, that’s the whole game, you can buy cheap stocks all year but if no-one else sees them that way then you have capital sitting there achieving nothing. When adding this overlay performance is significantly increased, it’s actually hard for people to do, they see a stock up 50%-100% and don’t buy for that reason, I don’t care because I know it’s still cheap.
Also some other relevant info,
Momentum alone typically performs better when we increase the rebalance period, for example from yearly to qtr to monthly. This doesn’t apply in my model.
Interestingly the more concentrated the portfolio the higher return, my asx200 model this also does not apply, in fact a portfolio of 30 asx200 stocks will before the same as a portfolio of 6 stocks. Small caps the more concentrated the better.
And yes I use a screener but I’m not using any ratio analysis, I use my own DCF model to value the stocks. Momentum factor is simply total return, I’ve ised plenty of other momentum factors but this simple one works the best.