In our Ranking Spreadsheet we calculate “momentum” over two time periods – usually 91 days (3 months) for our short term measurement and 182 days (6 months) for our long term measurement. If we are monitoring/adjusting our portfolio monthly (~33 days) it is interesting to look at what kind of returns we might expect to see over the 33 day period based on the momentum readings we see in the spreadsheet.
Some members may find it difficult to “visualize” exactly what we are doing, so the following graphic is an attempt to, perhaps, make it a little easier to understand:
The above plot shows actual data for VTI. The blue peaks and valleys show the value of the short term (91 day) momentum. As can be seen, the value of this parameter oscillates between ~ +/- 15%. The same thing holds for the (182 day) long term momentum (green plot) that oscillates between ~ +/- 10%. The time period along the x-axis is ~ 4 years. For positive momentum values (above the axis) when the blue peaks can be seen above the green peaks, short term momentum is greater than long term momentum and when the blue peaks are hidden behind the green peaks the short term momentum is lower than the long term momentum. The above graphic is not quite scaled correctly but (approximately) when there is a cross of the blue and green lines (e.g. orange squares) this would correspond to a change in the “Absolute Acceleration” number we see in the spreadsheet i.e. it would be positive if we can see the blue, negative when the blue is hidden.
Reverse the above statements for troughs below the horizontal axis – but we’re not too interested in these.
The dark red line shows the 33 day (future) return from the date on the horizontal axis at which the momentum measurements are made. e.g. at the bright red line, had an investor bought VTI then he/she would have seen ~5% return over the next 33 days. Note the lack of data at the right hand edge of the graphic since, obviously, the 33 day future return cannot be measured ahead of time.
The simplest observation to be made from looking at this graphic is that generally, if both short and long term momentum is positive (e.g. in the area of the yellow oval) then we have a high probability of seeing a positive return (dark red line) if the asset is held for 33 days.
We can also see from the above that momentum investors will not benefit from “bottom fishing”. Note the high returns in the blue oval at the left side of the graphic – but the negative short and long term momentum values. Momentum is a longer term trend following system and “lag” is an inherent feature of the methodology.
I don’t know whether this will help members visualize what we are doing a little more clearly – but I thought I would post in case it helps.