The strategy determines whether an asset's price is exhibiting an upward (positive momentum) or downward (negative momentum) trend by assessing the asset's return over a given period (standard look-back period: 12 months or approximately 250 trading days). Some studies recommend calculating momentum by deducting the corresponding Treasury bill rate from the measured performance.
Absolute Momentum Indicator
The Absolute Momentum Indicator displays the rolling 12-month performance (measured over 250 trading days) and plots it against a horizontal line representing 0%. If the indicator crosses above this line, it signifies positive absolute momentum, and conversely, crossing below indicates negative momentum. An additional, optional look-back period input field can be accessed through the settings.
Hint: This indicator is a simplified version, as some academic approaches measure absolute momentum by subtracting risk-free rates from the 12-month performance. However, even with higher rates, the values will still remain close to the 0% line.
Benefits of Absolute Momentum
Absolute momentum, which should not be confused with relative momentum or the momentum indicator, serves as a timing instrument for both individual assets and entire markets.
Gary Antonacci, a key contributor to the absolute momentum strategy (find study below), emphasizes its effectiveness in multi-asset portfolios and its importance in long-only investing. This is particularly evident in a) reducing downside volatility and b) mitigating behavioral biases.
Moskowitz, Ooi, and Pedersen document significant 'time series momentum' across various asset classes, including equity index, currency, commodity, and bond futures, in 58 liquid instruments (find study below). There's a notable persistence in returns ranging from one to 12 months, which tends to partially reverse over longer periods. This pattern aligns with sentiment theories suggesting initial under-reaction followed by delayed over-reaction.
Despite its surprising ease of implementation, the academic community has successfully measured the effects of absolute momentum across decades and in every major asset class, including stocks, bonds, commodities, and foreign exchange (FX).
Strategies for Implementing Absolute Momentum:
To Buy a Stock:
- Select a Look-Back Period: Choose a historical period to analyze the stock's performance. A common period is 12 months, but this can vary based on your investment strategy.
- Calculate Excess Return: Determine the stock's excess return over this period. You can also assume a risk-free rate of "0" to simplify the process.
- Evaluate Momentum:
- If the excess return is positive, it indicates positive absolute momentum. This suggests the stock is in an upward trend and could be a good buying opportunity.
- If the excess return is negative, it suggests negative momentum, and you might want to delay buying.
- Consider further conditions: Align your decision with broader market trends, economic indicators, or fundamental analysis, for additional context.
To Sell a Stock You Own:
- Regularly Monitor Performance: Use the same look-back period as for buying (e.g., 12 months) to regularly assess the stock's performance.
- Check for Negative Momentum: Calculate the excess return for the look-back period. Again, you can assume a risk-free rate of "0" to simplify the process. If the stock shows negative momentum, it might be time to consider selling.
- Consider further conditions:Align your decision with broader market trends, economic indicators, or fundamental analysis, for additional context.
- Important note: Note: Entering a position (i.e., buying) based on positive absolute momentum doesn't necessarily mean you must sell it if it later exhibits negative absolute momentum. You can initiate a position using positive absolute momentum as an entry indicator and then continue holding it based on other criteria, such as fundamental analysis.
- Reassessment Frequency: Decide how often you will reassess the momentum (monthly, quarterly, etc.).
- Remember, while absolute momentum provides a systematic approach, it's recommendable to consider it as part of a broader investment strategy that includes diversification, risk management, fundamental analysis, etc.
Relevant Capital Market Studies:
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