MoneyMagpie

Feb 20

Momentum Trading

Reading Time: 3 mins

The theory of Momentum Investing, like all the best ideas, is simple – the greater the amount of money that is being invested into a fund, or asset class, the quicker its value will rise. This will in turn attract further investment, pushing the price even higher.

If you remember the 1980s film ‘Trading Places’ you probably already know more about momentum investing than you thought. Eddie Murphy and Dan Aykroyd starred in the comedy film telling the story of a snobbish commodities broker and a canny street hustler.  To settle a bet on whether it’s a person’s environment or heredity that determines how well they will do in life, the millionaire brothers Mortimer and Randolph Duke arranged for their positions to be reversed and then watched to see how they survived in their new found circumstances.

The same year Richard Dennis set up the turtles experiment to settle a similar argument that he was having with his long-time friend Bill Eckhardt  – were great traders born or made? Eckhardt thought that trading was an ability embedded in your DNA, Dennis, (a momentum investor) was convinced it could be taught.

Richard Dennis was born in Chicago in 1949 and began trading commodities in the early 1970s. He started with a small loan from his family and by 1973 his capital had risen to $100,000. At the end of the following year he was a millionaire. By the early 1980s he was reportedly worth over $100 million.

They advertised for trading apprentices in Barron’s, the Wall Street Journal, and the New York Times. The ad stated that after a brief training session, the trainees would be supplied with an account to trade. Dennis selected 21 men and 2 women and invited them to Chicago for a two week training course. They were then given small trading accounts and asked to trade for one month. After this trial period he then gave the ones who traded successfully his own money ($1 million) to invest. In the next five years they are said to have made an aggregate profit of $175 million.

Momentum v Value Investing

The Value investor will aim to buy low and hopes to be able to sell high, whilst the Momentum trader will buy high and sell higher. The aims are similar except that the momentum investor follows a key principle, succinctly described by the legendary American investor Jesse Livermore “Don’t take action with a trade until the market, itself, confirms your opinion. Being a little late in a trade is insurance that your opinion is correct”. The strategy works best in a Bull market and is least effective when the markets are undecided and volatile.

Many professional investors have a mandate to be fully invested at all times – as a private investor you have the luxury of only playing the markets when conditions are favourable. There’s nothing wrong with heading for harbour, and moving your investment to cash, in uncertain times.

Momentum Trading Funds

In 2010 the founders of Saltydog Investor set out to prove that the same ‘momentum’ principles could work for private investors looking to take control of their ISAs, SIPPs, and other investments. To avoid the problem of researching individual companies we decided to invest in funds. We let the various investment houses use the resources available to them to select the constituents within the funds – all we have to do is track their relative performance to see which ones are doing it the best. We then use the leading funds in each IA (Investment Association) sector to determine which sectors to invest in. We trade through a low cost fund supermarket where we can switch between funds without incurring prohibitive costs.

To establish the direction of  ‘Momentum’  in the markets, we generate up to date fund and sector performance data highlighting what is doing well now – knowing what was performing one, three and five years ago is useless. We analyse the sector movements, and then rely on our unique Saltydog groups to rank the sectors according to how volatile they have been in the past. We use these groups to control the overall volatility of our portfolio, and only invest in the ‘riskier’ groups when their recent performance justifies it. Having identified the leading sectors we then look for the best performing funds based on their recent performance.

Over 4 years on and how have we done?

In November 2010 we invested £40,000 in a fund supermarket account and started our own ‘cautious’ portfolio – The Tugboat – where minimising losses is as important as making gains. We avoided the major market corrections of 2011, 2012, 2013 and more recently at the end of 2014. Since launch the overall value of our demonstration portfolio has gone up by 45%.

Saltydog graph showing Tugboat Portfolio

 

To find out more about the service we provide, and the 2 month free trial that we offer to all new members, go to our website www.saltydoginvestor.com

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