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In this post, you’ll discover a simple, step-by-step guide to using a momentum strategy with ETFs. You'll learn how to spot trends in the market and use them to your advantage. This strategy is straightforward and can help you make more informed investment decisions with less effort. By reading this guide, you’ll gain a practical tool to increase your returns while reducing your risks. This approach is ideal if you want a clear, easy-to-follow method to grow your investments without getting overwhelmed by complex strategies.
This article is a website version of our weekly FREE Best Ideas Newsletter sent on 26.03.2024. Sign up here to get it in your inbox every Tuesday.
In three months, my ETF momentum strategy is up +14%, +30% and +17%. This email shows you exactly how to implement it in your portfolio.
Background
At the end of last year, I started testing an Exchange traded Fund (ETF) momentum strategy and it's performing great.
I invested in three ETFs with good momentum. In three months the first one is up 14% the next 30% and the last one 17%.
As I was still experimenting, I invested in small steps and now it is about 15% of my portfolio. Overall, I'm very satisfied.
I Did Not Just Jump on The Bandwagon
Like you I of course I did not overnight decide to implement it, it followed months of research. And it took a lot of convincing.
As you know I'm a hardcore value investor and buying ETFs with the highest momentum means you're buying stocks like NVIDIA and the largest tech companies that have been driving the market higher.
But the research was convincing, and I took really good care to limit the risk with good risk management tools.
Why Momentum?
You know momentum is a factor we've built into most of our investment strategies, but I never implemented a pure momentum strategy.
It all started a long time ago when I read a book by Gary Antonacci called Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk.
We also wrote two articles on it which you can read here:
Mastering Dual Momentum: The Art of Combining Absolute and Relative Strength
Meet the inventor and author of dual momentum investing - Gary Antonacci
How To Implement an ETF Momentum Strategy
To implement the strategy, you need 12 and one month return of a lot of ETFs covering different countries, industries, and investment strategies.
If you are a subscriber you can use the data from our ETF Momentum Dashboard or you can use any good ETF data source.
Step by Step Instructions
Step #1: Sort your list of ETFs by 12 months return from high to low.
Step #2: Remove the ETFs with a return less than the risk-free rate. I use the three months US treasury rate.
Step #3: From the remaining list deduct the one month return from the 12-month return. This gives you 12-1-month momentum.
Step #4: Sort the list by 12-1-month momentum from high to low.
Step #5: Invest in the top three to five ETF's after making sure that they are not all in the same country or industry to give you more diversification.
Step #6: As ETF trading costs are low you can rebalance as often as you like. Monthly may be too often but every three to six months should work fine.
Why 12-1 Month Momentum
I use 12 - 1 month momentum to avoid ETFs that gone up a lot in one month and may correct the following month. In other words, it is a risk management or selection criteria to make sure you are not investing in an asset that jumped in price recently and may correct.
You Are Jumping on The Fastest Moving Train
So, in simple terms this is what you do with the strategy. You first look to see what trains are moving forward (beating the risk-free rate), if they are you jump on the train that is moving forward the fastest.
Risk Management
Because momentum can turn around fast risk management with momentum strategies are very important.
I follow a trailing stop loss strategy with a stop loss tighter than I do for individual stocks. For example, 10% to 15% instead of the normal 20% that I suggest for individual stocks.
I also look at the option adjusted high yield spreads in the US as well as in Europe. I use this because of this great piece of research I came across: A Momentum Crash Course - High-yield spreads can predict crashes in long-short momentum portfolios.
They found the following:
There is a strong relationship between the level of high-yield spreads and the one-month returns to the momentum factor. Specifically, tight high-yield spreads are associated with robust momentum premia, while elevated spreads (400-700 basis points) predict weaker returns. The right signal to move out of the momentum strategy—or even to initiate strong bets on reversals—has historically been when spreads exceed 700 basis points.
To track high yield spreads, I use this website: St Louis FED – High Yield Option Adjusted Spreads
As spreads go up over 4%, I start reducing my positions.
Quant Value newsletter update
Performance last week was good, with the following highlights:
- BlueLinx Holdings Inc. +12%
- Southern Cross Electrical Engineering +9%
- Kitano Construction Corp. +8%
Subscribers are still sitting on the following solid gains:
- North America +66%
- Europe +23%
- Asia +24%
- Crash portfolio (2022) +59%
If these ideas sound interesting, you can get more information here: Your Treasure Map to Europe, Asia, and North America's Hidden Gems!
Shareholder Yield Letter update
Since May when we started the 40 ideas have already paid an average dividend of 1.7% and am sitting on an average return of 11.2%.
Top performers are an oil company, and the two Japanese trading companies Warren Buffett also has in his portfolio.
Dividends keep in rolling in and will increase substantially soon when the yearly dividend paying companies start paying. This makes it a great portfolio if you are looking for income ideas.
As things stand today the portfolio has an average historical dividend yield of 4.5% and bought back 4.0% of their stock last year. This gives you an average Shareholder Yield of 8.5%!
If this sounds like the kind of companies, you would like to invest in you can find more information here: Invest big, win bigger with our market beating large-cap strategy!
Your ETF momentum analyst wishing you profitable investing
Frequently Asked Questions
1. What is ETF momentum investing?
ETF momentum investing involves selecting ETFs that have shown strong performance over the past 12 months. The idea is to "ride the wave" of these successful ETFs for potentially higher returns.
2. Why should I care about momentum when picking ETFs?
Momentum is important because it can help identify ETFs that are trending upwards. By investing in these, you may increase your chances of earning higher returns.
3. How do I choose the best ETFs using momentum?
Start by sorting ETFs by their 12-month returns. Remove those that performed below the risk-free rate. Then, pick the ones with the best 12-1 month momentum, ensuring diversity in sectors and regions.
4. Is momentum investing risky?
Yes, momentum can be risky because trends can reverse quickly. That's why using risk management strategies, like stop losses, is crucial to protect your investment.
5. How often should I rebalance my ETF portfolio?
Rebalancing every three to six months is ideal. This helps you stay aligned with the momentum strategy without over-trading, which could lead to unnecessary costs.
6. What’s the 12-1 month momentum, and why is it important?
The 12-1 month momentum is the difference between an ETF’s 12-month and 1-month return. It helps filter out ETFs that may have spiked recently but could drop just as fast.
7. How do I manage the risks associated with momentum investing?
Use a tighter stop-loss (around 10-15%) and monitor high-yield spreads. When spreads are high, it's a signal to reduce momentum positions, as the market may turn.
8. Can I use this strategy with any ETF?
Yes, but it's best to focus on ETFs from diverse sectors and regions. This ensures you aren't overly exposed to one area, reducing your overall risk.
9. Why does this strategy work?
Momentum works because it capitalizes on the market’s tendency to continue trends. By jumping on "moving trains," you aim to catch the upward ride before it ends.
10. How much of my portfolio should I allocate to this strategy?
Start small, around 10-15% of your portfolio. As you gain confidence and see consistent results, you can consider increasing your allocation.
PS To find great companies that exactly meet your investment strategy right now click here.
PPS It is so easy to forget, why not sign up now before you get distracted?
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