The Perils Of Momentum Strategies
Not as well as then long agone I was an agnostic with honour to choosing betwixt mean-reverting as well as momentum models: I felt that depending on the item model or environment, each tin live profitable. Lately, however, I am increasingly skeptical nigh the long-term profitability of momentum models. The principal ground is the increasing contest with traders, algorithmic or otherwise.
As I mentioned inward my previous post, when to a greater extent than as well as to a greater extent than traders create upwards one's psyche to adopt mean-reverting strategies, all they exercise is to eliminate the trading opportunity. The marketplace becomes efficient, as well as nobody makes whatever money, but nobody loses either. In contrast, when to a greater extent than as well as to a greater extent than traders create upwards one's psyche to adopt momentum strategies, the momentum volition live established sooner as well as sooner. For e.g. inward the instance of event-driven strategies which are mostly momentum-based, the novel equilibrium cost volition conduct keep been established almost instantaneously afterwards the number is publicly disclosed. Under this circumstance, whatever momentum trades that are entered merely a footling fleck belatedly volition non alone endure zilch profit, but volition probable endure losses equally mean-reversion almost inevitably takes over. But how before long exercise nosotros take away to motility into inward gild to avoid this fate? (It can't live likewise before long either because frequently a tendency take away to live established outset inward gild to trigger an entry signal.) It is unfortunately a moving target equally contest increases: 1 24-hour interval before mightiness move now, but may non live sufficient a few months from now. (The move out merchandise also suffers the same problem, equally nosotros don't know how long the momentum volition last.) It is a unsafe game to play.
Indeed, fourth dimension is frequently a friend of the mean-reversion trader: the longer s/he waits, mayhap the to a greater extent than profitable the trading opportunity. And if s/he enters likewise early on as well as suffers a loss, s/he tin e'er double the position. As I explained inward a previous article, stop-loss should to a greater extent than frequently than non not live applied to mean-reverting trades on a brusque time-scale. So fifty-fifty if the trader does non double-up the position, an eventual re-couping of the loss is to a greater extent than than likely. On the other hand, fourth dimension is an enemy of the momentum trader: if s/he loses the first-mover payoff as well as suffers heavy loss, I argued inward that article that a stop-loss is advised, as well as therefore the loss is forever locked-in.
Given this asymmetry, it is no wonder that algorithmic traders conduct keep been alarm me long agone that it is difficult to discovery a profitable momentum trade. And I was giddy plenty non to pay psyche to them until now.
As I mentioned inward my previous post, when to a greater extent than as well as to a greater extent than traders create upwards one's psyche to adopt mean-reverting strategies, all they exercise is to eliminate the trading opportunity. The marketplace becomes efficient, as well as nobody makes whatever money, but nobody loses either. In contrast, when to a greater extent than as well as to a greater extent than traders create upwards one's psyche to adopt momentum strategies, the momentum volition live established sooner as well as sooner. For e.g. inward the instance of event-driven strategies which are mostly momentum-based, the novel equilibrium cost volition conduct keep been established almost instantaneously afterwards the number is publicly disclosed. Under this circumstance, whatever momentum trades that are entered merely a footling fleck belatedly volition non alone endure zilch profit, but volition probable endure losses equally mean-reversion almost inevitably takes over. But how before long exercise nosotros take away to motility into inward gild to avoid this fate? (It can't live likewise before long either because frequently a tendency take away to live established outset inward gild to trigger an entry signal.) It is unfortunately a moving target equally contest increases: 1 24-hour interval before mightiness move now, but may non live sufficient a few months from now. (The move out merchandise also suffers the same problem, equally nosotros don't know how long the momentum volition last.) It is a unsafe game to play.
Indeed, fourth dimension is frequently a friend of the mean-reversion trader: the longer s/he waits, mayhap the to a greater extent than profitable the trading opportunity. And if s/he enters likewise early on as well as suffers a loss, s/he tin e'er double the position. As I explained inward a previous article, stop-loss should to a greater extent than frequently than non not live applied to mean-reverting trades on a brusque time-scale. So fifty-fifty if the trader does non double-up the position, an eventual re-couping of the loss is to a greater extent than than likely. On the other hand, fourth dimension is an enemy of the momentum trader: if s/he loses the first-mover payoff as well as suffers heavy loss, I argued inward that article that a stop-loss is advised, as well as therefore the loss is forever locked-in.
Given this asymmetry, it is no wonder that algorithmic traders conduct keep been alarm me long agone that it is difficult to discovery a profitable momentum trade. And I was giddy plenty non to pay psyche to them until now.
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