Quantitative Momentum Systematic Process To Identify High Momentum Stocks Aaii

TITLE: Quantitative Momentum: A Systematic Process to Identify High Momentum Stocks CHANNEL: AAII DATE: 2020-09-10 ---TRANSCRIPT--- thank you ryan thank you everybody for joining us tonight uh we have a special guest with us uh jack vogel uh jack i was thinking about it we’ve it’s been several years since we first met i think it was my been at a conference a webinar or seminar some point uh but uh it’s good to see you uh shame it can’t be in person uh but uh jack worked for work for author architect uh he’s also uh teaches at villanova i believe he said you teach a master’s class that’s at villanova is that correct i taught a couple ones the most recent one was yeah mba equities class that’s correct so right and you’re doing it i understand by uh by zoom instead of in person yeah so this summer was the first uh online one um went pretty well i think it was nice being able to easily change from like screen to screen right because sometimes someone will ask a question and it’s easy to just go like oh hey i already know what that answer is just gotta google it real quick and then pull it up so but uh but yeah i know we met a couple years ago and uh always loved uh doing these events with you guys and um too bad time in person but one day it will be absolutely well uh just a quick question i know you’re a big philadelphia sports fan uh what’s what’s your outlook for the eagles since we have football about to start uh yeah so eagles um you know not not uh definitive on how they’re gonna be this year obviously there’s no training camp so it’s kind of hard to figure out that’s probably for every team but you know just kind of hoping uh carson wentz can play 16 games because um you know even last year he finally did and then on i think like the third play in the playoffs he got injured and was out so just cross my fingers that we have a quarterback that can finish the whole season although a couple years ago it was good we had nick foles come in so and uh i know uh chicago actually has souls right right i think they signed him this all season so yeah hopefully he brings the magic there hopefully so we got trubisky starting but uh we’ll see we’ll see whether or not he’s still the starter at the end of the season yeah but jack i know everyone’s here not to hear about sports uh but to hear your presentation so let you take over and to the audience i’ll be uh monitoring questions and uh we’ll be passing them along to jack uh either during the seminar either during his presentation or right afterwards so go ahead jack it’s all yours sounds good so i just wanted to give a quick overview so our firm south architect we uh are an asset management firm but also you know have a lot of information and educational resources on our website you know we try to you know we have a motto of trying to empower investors through education very similar to you know aai where it’s an educational resource obviously we are a for-profit business but we want to make sure everyone understands exactly what we’re doing so on our website underneath the blog we have a lot of articles about factor investing and we have some tools on there such as you know uh ways to look at socks ways to look at etfs so those are free tools on our website um and again that’s just kind of what we do we talk about factory investing so i know last week sounds like larry swedrow who’s actually uh would say friend of our firm and just uh he writes blog posts occasionally uh from time to time and i’ve met larry in person he’s a great guy he talked about um a kind of overview of factor investing and shrinking alpha so tonight what i want to do is do a deep dive into one specific factor that a lot of people like to use which is momentum and specifically you know this title is talking about our quantitative momentum indices um and really this was a book west and i wrote a couple years ago called quantitative momentum so you know it’s out there and it kind of outlines the process that we use to build a systematic momentum portfolio but also outlines besides just the process kind of the logic behind it how it fits into a portfolio and why we chose one approach over multiple approaches or different approaches so we tried to write this book to put together and compile a lot of the research about one factor momentum and put together basically from all of our reading and all of our synthesizing of the information how we would build a portfolio so that’s essentially what this presentation is going to be about i’m going to talk about why we do it how we do it and then you know some of the pros and cons of such an approach so first thing just to make sure that everyone’s on the same page i want to cover what does momentum mean and i’m going to say what does momentum mean in this context specifically um because for uh in other papers and uh other articles it could mean something different so i did a simple momentum example to start and what i have here is basically on the x-axis we have time on the y-axis we have our return right and when i talk about momentum throughout the entirety of this presentation this is what we’re talking about we’re going to say at one point in time let’s just say right here we are going to look at the cumulative return of a stock over the past let’s say 12 months and we’re going to compare different stocks so in this example it’s two stocks so here we see that stock a has a higher return than stock b therefore if i was running a momentum strategy i would buy stock a and not buy stock b right or i would if i was running a long short strategy again very complicated with caveat only skate people want to do that but you would buy a and sell b right so when we talk about momentum this is what we’re talking about so now if we were talking about for example a thousand stocks or 500 socks you would run the same thing you would say hey we are going to examine for all 500 stocks the total return over the past year and we are going to buy the top 20 so that would be the top 100 stocks the remaining 400 we would not buy right and in academics uh usually you look at the 12 month return skipping the most recent month the main reason that we skip the last month is we know that short term momentum i.e last month’s winners actually do bad the next month and last month’s losers do better so by skipping this last month you uh in effect uh try to minimize information that you know at least historically axannie was a was a bad signal right so again simple momentum is just compare a and b by the winner and so this uh i’m going to walk through our index methodology and when we create this index and create this strategy again when we talk about it in the book this is you know there’s a whole chapter on every single item here right i’m not gonna spend a chapter uh on here otherwise we’d be here till you know uh four in the morning but essentially it is a filtering process and the filtering process uh basically has five steps so the first step is to identify the universe and what we do here is let’s for example say we’re going to look at the top thousand firms right so we’re going to look at like need and large cap stocks one of the reasons there is just um you know we want to look at firms at least historically you don’t want to have a micro cap effect whereby you try to create a strategy that would basically be untradable with any amount of assets the second step is our core momentum screen and so from here this is kind of the biggest most important step what do we do we go from a thousand stocks to 100 stocks and we do this by filtering all of the stock so of our thousand we filter and we select the top 100 stocks on their returns over the past year right so again started with a thousand step two we’re down to a hundred now step three we call it a momentum quality screen so you know maybe not the best wording so this is not a quality screen what we’re looking for is like basically the quality of momentum and i’m going to do a deep dive here so you go from 100 to 50. the fourth step is seasonality i’m going to talk about why we specifically rebalance our momentum portfolio in specific months right so we’ll get to that and then the last is we just equal weight these portfolios sorry equal weight the portfolio of our 50 stock 50 stocks all right so again step one uh is just identify the universe we are basically looking just at mid and large cap stocks and the main reason you want to do that um you know if you use any tools that are doing back testing to try to figure out you know hey is this a good strategy that i should do i would say just for your own knowledge one thing you always want to do is make sure that your strategy works on like larger stocks uh you know mid-large cap at least like top thousand because a common error i see is you know you can have this micro cap tilt so specifically for this we attempted to eliminate all the small caps and the micro cap stocks now the second step again this is the most important step of our process and you know it’s basically the momentum screen and you know the this is a quote from you know a paper called dissecting anomalies written by uh falmen french in 2008 and the quote is you know the premier anomaly is momentum and you know when we look at academics attempting to uh again what do academics why do they even care about stock returns well what they’re trying to do is they’re trying to better understand right why like a one factor model such as like the capital asset pricing model where there’s just beta why does that not explain or have like an r squared of one right so when you run a cap model which is one factor being beta you see that the r squared is only 66 percent and so what that means is it can only explain 66 percent of the variation of stock returns so what academics have done is try to come up with factors or uh things that are uh related among certain types of stocks so the first two that farm and french came up with were size and value right but momentum is one that when you add that you get better explanatory power and so this is just highlighting you know uh that this is a pretty good factor and again when we talk about the core momentum screen this is what i was talking about before what we are going to do is we are going to take our universe of a thousand stocks and effectively compare a and b and we pick this and we would not pick this stock so now you can say well hey jack what is the evidence that this strategy makes sense what is the evidence that i should even consider this so the original paper within the academic universe was a paper called returns to buying winners and selling losers implications for stock market efficiency by jaguation tip so this was in 1993 and what they looked at um was effectively selecting stocks based on their past you know j month returns and then holding the positions for k months right and what they found so these are just all the various iterations um i’m sure when they ran this it probably took a long time a lot of computing power to look at all the stocks do the filtering if you did this now with a modern computer you could recreate this table in probably uh two hours right so or less than that um so but back in the day this was a huge a lot of data work went on they basically looked at a ton of stocks over all time and they said hey we’re going to vary our look back period i.e the last three months returns the sorry the last three months returns the last six months returns 9 and 12 and then when we look and we say hey we’re going to have our winners over 12 months we’re then going to hold them for 3 months or 6 months or 9 months or 12 months right so there’s actually a very large amount of data work that went into uh creating this um and in 1993 you know computers were clearly not what they are today um so but a lot of data work was done and what you found was that one of the best strategies and what they found was what’s called intermediate term momentum i.e a 12 month look back when you look at the winning stocks the these are basically the buys right compared to the losing stocks this hypothetical long short portfolio had a very high return so this is 1.3 percent monthly right so if you multiply that by 12 right my math’s not as sharp as it used to be but that’s around like 15 right so 15 annualized on a long short portfolio where in theory you’re also going to earn you know returns the whole either holding cash or you could in theory hold the market and then create a long short on top right so this is why this is called an anomaly they see this and they say hey this is this is a great return now what’s another way to view this right you can just look as opposed to looking at you know this table right we can look at a graph and so in this graph i actually went to so this is from our both quantitative momentum the image the data for this graph you can go out and actually get yourself right so this data is from ken french’s website again one of the authors for a lot of academic papers he has an incredible website whereby he will create sorts of portfolios based on certain factors and then publish the returns to these portfolios right so he has access to the academic databases that happen to have all the stock returns going back to 1927. so this is from 1927 to 2014. and let me explain the four return streams that we have here so the first one here this is this dotted line that ends up over here around a thousand dollars that is the risk-free rate of return i.e if you just invested your assets from 1927 to 2014 into treasury bills what would you have returned you know you would have a thousand dollars now the second one right here is the s p 500 so these are returns to let’s just call it the 500 largest stocks in the universe and what you notice is that there’s this thing called the equity risk premium stocks did better than cash right now the other two portfolios are intermediate term loser that’s this bucket down here an intermediate term winner so what does canned french do here what he does is he takes every single month he will take every stock that is existed in the united states right that’s on the chris database and he’s going to do a look back period on their past year momentum so past 12 months ignoring the prior month right so it’s actually 11 months right and what he does is he’s going to say hey these these are the top 10 of all stocks i’m going to create a portfolio right so if i thousand stocks these are the 100 highest momentum stocks these are the 100 lowest momentum stocks so he creates his portfolio he market cap weights the portfolio and he holds it for one month then he rinses and repeats and does the same thing and what you see is that high momentum stocks did better than not only cash but they also did better than the market now an interesting alternative is we look at intermediate term loser so again this is a portfolio of stocks that is rebalanced every month is market cap weighted and crazily if you had bought this portfolio you would have had a return not just lower than the market but lower than cash right so the old saying is winners keep winning losers keep losing so this is you know when we talk this is obviously is a big deep dive into the momentum factor this is a big reason why uh a lot of investors and firms and people like this this fact this factor called the momentum factor all right and uh charles if you have any any questions specific to any charts feel free to chime in here yeah actually we do a couple questions uh really just people are asking about the um the 12-2 and so could you go over again why the one month the first month is excluded i should say the last month is excluded from the calculation yeah that that’s a great question so i’ll say this you don’t have to do it right so again uh in general the 12-2 momentum is highly highly correlated to 12-month women right so you know if it’s easy to not do it uh you know i would still be okay and say yeah it’s it’s a reasonable approach to just do 12 months right um so i agree uh that’s a common question we have and the first thing i always say is if it’s impossible to do just still use 12-month movement right but it for us to why we actually do that an interesting kind of crazy approach and i will share this result actually i’ll just share actually can’t find the article quick enough um but uh in our book we actually highlight and show you the chart which is kind of crazy if you look at short term i.e one month so if i change this not to 12-2 but to one month look back period and i said short-term loser short-term winner so the winners of last month the losers of last month and i just graphed that it would be the exact opposite crazily right so short-term losers would have this positive return short-term winners would be negative right and so that’s why you know from from my perspective and from academic perspective if you know that one month returns have a negative relationship i.e the winners last month are going to do bad the losers last month are going to do good you don’t want to like add any possibly confounding information into your screen does that make sense absolutely and i did get another question asking about different time periods whether you could go shorter than 12 months yeah you could um and again that’s uh you know one of the things right here right so if we look at the nine month look back period right so this is again looking at nine month winners and nine month losers you see that there’s still this positive with a t stat of three return right um and and same thing here you know six month even three month three month not as much now interestingly enough in the paper they have this lag where we talk about lagging the returns right because remember i told you that we kind of know that there’s this weird negative correlation and what you see is actually then the tsats get much better when you lag which again is why we use this 12 too um it wasn’t exactly tested the exact way in that paper but panel b actually kind of highlights one of the reasons you want to use this lag right so the t statistic on the six month look back is 2.44 when you add the lag it’s 3.37 um so again that’s a reason that we we kicked this out so yes you can use uh you know so what i’d say is you want to use what’s called intermediate term momentum um whereby i would say you probably want to be like six months to 15 months somewhere in there right because again when you go short term when you go to like one month or less it’s the opposite so you don’t want to go too short because you’re you can uh actually get the literally the exact reverse effect within prices does that help that does and just one more question um and i just made a comment to the audience um i know jack made a reference to ken french’s database uh we’ll include it in the show notes um you can also just google ken french database it’ll come up uh but someone just asked real quick if you can re-explain the concept of a long short portfolio yeah um and so real quick you know here’s this database right i believe you can see my website browser correct yes yep yeah and so for example if you just wanted to look so i’m just on kent like all i just did was google ken french data click button and if you were said hey i would like to just look at the momentum deciles right well you have to you know just kind of get familiar with this i’ve been on this website a million times so i know where this is right this is uh sorts involving prior returns and so here you go 10 portfolios sorted on momentum if i hit csv download open right what this is will do hopefully my excel doesn’t crash here um you’ll see you’re going to have 10 decimals whereby you have high returns right so this is literally the low momentum decile this is the high momentum decimal right and so these ones are what’s called value weighted returns i.e market cap weighted he even has returns down here that are equal weighted so as opposed to simply market calculating the positions he equal weights right here right so this is how you get ken french’s data now long short portfolios what are those right so a long short portfolio very simply um so so the momentum factor uh is actually done using the top uh i believe 30 so it would be these average of these right but created as one portfolio but for example sake if i said hey i’d like to create a momentum long short portfolio right so long short this is how academics would do it they would say we’re going to take the high return subtract off this return right and you know just copy that down that’s my new long short portfolio right because you’re basically going long the high momentum stocks oops you’re going long the high momentum stocks and you’re going short or you’re getting the opposite return of the low momentum stocks right and again the main reason that academics examine this is because um you know uh you want to create a factor that’s different than equity beta right so equity beta is going to obviously be the most important factor i.e what does the market do because if the market goes down 50 percent yeah maybe the high momentum stocks are only down 40 and the low momentum are down 60 but everything is down right so in order to examine cross-sectional differences you create these long short portfolios and that’s this is how academics do it they go long this short that right and actually it explicitly outlines it right here if you look at the momentum factor and click details he actually explicitly says how he builds the portfolio so so um but yeah good good question about the momentum factor and so here this is again just the long only return to high momentum and long low momentum not long short does that help that that’s great uh to the audience i’m monitoring the questions um i am keeping track of them but jack i’ll let you uh get back to your presentation and uh yeah q afterwards all right so then the second thing is you know um once you get down to these high momentum firms right so as opposed to simply just saying well you know maybe we could have thrown into town and said hey we’re just going to do momentum one factor right um a second thing is you could say well hey maybe we can figure out like a better way amongst the high momentum firms to identify maybe better momentum firms right and there’s numerous papers examining this um some like low volatility that generally tends to work uh trading volume has been found in an older paper to work but the main quality screen that we like is this interesting paper it was a working paper when i was a phd student finally got published uh made me being a phd student so it was fun for me to learn how to code this up but basically uh it’s called frog in the pan continuous information and momentum and the whole idea behind this is the authors had this idea that they basically said hey maybe the momentum anomaly is driven by certain types of stocks that basically have smoother paths and they had a neat title to the paper called frog in the pan and they called it frog in the pan um for the you know old example of if you put a frog into a pan of boiling water it’s going to jump right out right so if you throw it in it’s going to just hop out and that would be like a hoppy kind of momentum whereas if you put a frog into a cool room temperature uh pan and you slowly raise the heat unfortunately the frog would you know have a slow dyeing death so i guess neat title of the paper kind of cruel uh story about frogs dying but what it highlights is what they were trying to test in the paper and their test was hey let’s compare two stocks a and b and these are both high momentum stocks but let’s call them stock a right we’re going to call this this blue line or chrono call stock a boring big box right and so i like to use that name because it’s basically a stock that just kind of grinds along grinds along grinds along and it ends up being a high momentum so there’s no like crazy news stories nothing crazy um it just slowly grinds along uh the second one we’re going to call exciting nanotech right so this is a biotech firm that also does you know technology right so it does a ton of stuff and they have these discrete big large jumps right and in the paper they compare amongst the high momentum stocks and low momentum does stock a our boring big box do better in the future than stock b right and the idea would be that if it could be the case that if markets were pretty efficient when a interesting news story comes out about like a biotech firm for example maybe they get an fda approval well everyone’s probably going to look at it and be like well if they get approval this is what the stock should be efficiently priced in and that would mean that the stock price is probably pretty accurate so in the future there’s not going to be as much return whereas boring big box is kind of just grinding along and maybe people are overlooking it and so what we did in the paper and it’s also found in this actual academic paper they found that these boring big box kind of low lower volatility smoother price path momentum stocks do better right so in this chart let me explain what it is again this is a chart from the book but the evidence in the academic paper is similar so this bottom line is the s p 500 this middle line is the simple sort on momentum so essentially this winning portfolio right so this portfolio just using slightly different data is this middle line and then what we did is we said hey let’s use this frog in the pan metric right and look at the higher quality ones i.e the smooth ones and compare that path to the jumpy one right and what you see is that the smoother one is the top line and the jumpier momentum is the bottom line so it does appear that you know higher quality momentum i.e smoother momentum tends to do better than lower quality movement so that’s the third step in our process so again step one is like a thousand firms step two go to the top hundred step three go to the top 50 using this quality of momentum right and now step four uh is a momentum seasonality screen so one thing um when i was a phd student west i had an idea uh it was actually you know more west but then i kind of agree with them um was basically there was an idea that momentum may be seasonal right and the idea would be that at the end of every single quarter right what’s going to happen well if you’re a mutual fund or an institutional uh like an endowment or something right or even just an investment advisor you have to generally report your holdings quarterly and if you have to report your holdings you might not want to report that you happen to have like these crappy losing stocks in there and if you don’t want to do that what would that mean that would mean that you would actually have to get rid of the losers i sell the losers and buy the winners right so that’s moment and so that’s kind of the quarter end effect and then there’s also this year-end effect whereby everyone kind of knows this if you’re sitting on a game that and it’s a stock that you actually want to get rid of right there is no way you’re going to sell that on december 31st you’re going to wait till january 1 because by waiting one additional day to get to january what happens you don’t owe the taxes on that sale right assuming it was for a gain you don’t owe the taxes for like another 400 days right so there’s actual legitimate taxable reasons that in the fourth quarter people are going to sit on winners i.e there’s going to be less selling pressure and all of their losers what are you going to do well you’re going to make sure you sell those losers even if you want to keep them you’re going to sell them in december right and that’s basically momentum right not selling winners in december selling losers in december that’s literally the definition of momentum and what we see is that there’s this seasonal effect whereby quarter ending months tend to do the best and this is looking at the spread of high minus low so this is the long short portfolio but what it highlights is quarter ending months tend to do the best and so within our book when we examine this we said hey let’s do this smart rebalance let’s rebalance our portfolio going into these quarter ending months so we rebalanced at the very end of february because we wanted to get the momentum effect in march we rebalanced at the very end of may the very end of august and the very end of november right and so that was what we called the smart rebounds if you believe that there’s actually a seasonal effect amongst the momentum names right and then the dumb rebalance right we call that is you would rebalance at the end of basically the end of the quarter so the end of march end of june end of september and december and december you see january is actually the one month that momentum is like negative historically right and so this is our seasonality screen and the main reason that when we were balanced quarterly we end up rebalancing right before the quarter ending month right so you want to be in your names going into march june september december okay and the last thing that we do is you know we say we invest with conviction we take our 50 stocks we equal weight them and that’s our portfolio um and you know within our index and the strategy that we run um it’s definitely going to be different than the market this is a measure called active share and all that active share does is it basically if you compare one fund or one strategy to another strategy um it can either be zero meaning that the two strategies are exactly the same or 100 meaning that the two strategies are completely different there’s literally no overlap of the underlying holdings um and you know so when you run this systematic process in the u.s this was actually as of last year so it varies from time to time but when we ran this to last year um you know it was like 95 percent basically different than s p and for international it was almost 95 percent different than the efi index so that is a walkthrough of our five step process now a common question uh and something just i would like to highlight to everyone is about portfolio construction um and so i want to go over you know why we selected 50 stocks why we selected every three months and show you that while you might actually you know at least historically this was a good bet in short run time periods uh can definitely underperform so one thing we like to highlight is uh the returns to the s p 500 and vanguard value so this is over 13 years and what you notice is that the two portfolios are literally almost end up at the exact same point right um and this is not a dig on vanguard right because actually vtv costs less on a management fee basis then spy so again no dig on vanguard they’re great for investors i sent a ton of people there my wife used to work there um they’ve done a great thing for investors in lowering fees but this just highlights that although this said value it really isn’t building this portfolio that’s completely different than the market right um and so one thing that we did and i’m going to actually just highlight it here right because this is a um maybe a better chart that’s simpler to understand and we did this this is directly from the book quantitative event so a common question is well hey jack this makes sense you kind of told me that you do momentum and you know we’re going to start with mid-large cap stocks now i need you to help me with how do i build my portfolio right and when and when you get that question the question is okay well first off how often do i have to rebalance how many stocks should i hold so those are great questions right so i’m going to slowly we’ll slowly walk you through this chart which actually gives at least should it give you a understanding of the trade-offs of building it in different ways so what we did in this portfolio sorry in this chart is every month i took the 500 largest stocks so again this uh charts directly from our book the 500 largest stocks and every single month i use the the 12 2 momentum to screen and when i did this screen there were two variables and two ways i could vary how i build the portfolio the first is along the top so what the top is saying is every single month from my 500 socks i’m going to pick the top 50. now alternatively in the second column i picked the top 100 150 200 250 to 300 right so the top and all of the columns represent different number of stocks in the portfolio now what is this this is holding period for each stock so another common question is okay you tell me maybe i should buy 100 subs we’ll look at it here how long do i need to hold this now momentum right is one that the academics tested using one month rebalance but i went from one month down to two months three months all the way down to a year right so in my opinion there are there are two things that should jump out at this chart to you the first right is what one notices is historically right as one took a more concentrated position in momentum right it did better so the 300 stock portfolio did worse than the 50 stock portfolio right or the 150 it’s almost kind of kind of just shifts to the left right and this makes sense we already know that momentum works so if you know that something works it probably should work pretty well in the tails right the second thing is momentum is a strategy that you actually kind of need to rebalance more frequently right so when we look at this right going from one month down to three months we see actually almost like a two percent drop right now you could say well hey jack why did you guys do three months right well one thing we noticed is doing three months is still way better than doing 12 months you see this massive drop off amongst all right it’s almost three percent across the board right the main reason we did this and again this is more uh art less science right there’s no perfect uh answer here but there is turnover in this portfolio and so one thing that’s true is by turning over every month that’s 12 times a year by turning over every three months that’s only four times a year right so these again are paper the returns to paper portfolios so if you really had a look at the true returns after you have the trading cost it would have been lower and so by picking three months we think that’s more of a you know again art versus science that is just where we’ve we decided to fit and sit is a three-month portfolio so any questions on this chart yeah a few i’m right about your chart this just came through um uh keith asked why not the top 25 or 30 stocks instead of 50. so why not go even more concentrated yeah good question um in general that probably will work um you know one thing is uh as you know you know you really around like 30 250 stocks is when you generally get similar types of volatility um relative to the market right um so so you could do that uh we just ended up you know deciding to stay like in that 40 to 50 range um you know we actually when we run when we’ve run this uh we have gone down to like 40 45 stocks so not anti that um but you know this was just more for like expositional purposes to just kind of look at how it did um but i would just caveat any investor that you know you generally still want to have like a diversified portfolio so i i would at least start with 30 stocks that’s just always my general starting point uh because then you can reduce at least at some level like any use and credit risk of one firm uh by going at least 30 stocks and i know you all have a momentum etf how many stocks are held in that uh so we have uh 45 to 50 sucks in that and if you don’t mind going back a couple slides i did have a couple questions that people were asking about the quality measure the overlay or using the momentum and wondering exactly what i guess what’s being used for quality someone asked if the standard deviation of returns um is it something else yeah so so uh i’ll what i’ll do is i’ll send you the exact measure so you guys can take a look at it and you can um uh start you can take a look at it and everyone can look at the exact measure so it’s a variable it’s uh basically it looks at the accounts over the past year the number of positive days and the number of negative days right and then creates a percentage so for example say let’s say we had 250 trading days just because it’s a little late so my my brain’s not as smart so if we had 250 trading days let’s say you had 150 positive days and 100 negative days right it looks at the difference between positive minus negative so in that example it would be 60 positive minus 40 negative so 20 and then you multiply that by the sign of the momentum um and again this is just because they look at the negative momentum stocks like the losers as well right but for winning stocks in general they’re always positive right so in my first example that would be 20 positive right like the difference uh and then let’s just say you had another one that was 50 50 right so 50 positive 50 negative in that example you would pick the one that had more positive uh the dip like the 20 positive minus negative compared to zero percent which was 50 positive 50 negative right so the measure in and of itself if you don’t have daily data for every stock is actually kind of difficult to compute to be quite honest with you so again the whole idea if we look at this chart and just kind of visually think about what it’s actually trying to measure is to look at this so uh other ways you could measure as a proxy for a momentum quality screen would just be volatility right um or idiosyncratic volatility or beta so any of those measures would get you i would say very similar uh not exactly the same but would you know probably be uh very uh very close in relation to what this this is trying to measure and just to be clear because i the beta is probably an easier term for a lot of people to understand that are uh individual investors so basically looking for stocks with lower high momentum and lower beta versus high momentum and higher beta that’s correct yep that would be a simple way to do it that’s correct okay um and just i did have a couple questions regarding turnover um so any tips about rebalancing a few people asked about the tax impact uh you know one percent point if you rebalance right then the year early january the taxes are due soon um and another member asked uh well if you rebound more frequently how do you handle the tax situation with that yeah so so i would say there’s two answers that one is uh and again this is why factors are different so if i showed you this chart for value right it would be different because the difference between one one month and 12 month definitely it’s better for one but it’s not this like precipitous drop off right so what i would say is number one if you’re going to run a momentum strategy individually buying stocks you need to do it in like an ira type account right like tax shelter shelter types of accounts because the minute you start you know not rebalancing you lose a lot of the the edge of momentum right um so you know maybe you could do every six months um if you wanted to do it so one approach would be uh but but in general what i would say is like this is just the historical trade-offs of you know number of stocks and rebalance right but then obviously taxes come into play so number one is if you’re doing individual stocks you definitely want to do it in an ira type of an account or a tax sheltered account the second thing is uh you know momentum is is there are some momentum etfs that are out there and you know the etf wrapper in and of itself is actually a very tax efficient rapper because when the fund does the rebalance you know etfs just have an ability through the creation redemption mechanism to be somewhat more to be more tax efficient um so obviously i would say start an ira accounts if you’re doing individual stocks and then if it’s in a taxable account you can still do it with individual socks but i would say you might want to consider etfs possibly for this specific factor momentum and just one last question i’ll let you get back um i see a few questions about uh just about trading and transaction costs yeah uh how much of a drag is that uh i don’t know if you can comment on that or not yeah so let me bring this up sure so it’s definitely a drag right you can’t even you we can’t say that there’s no trading costs like even even just looking at that this is a paper portfolio i just we i told you that we went like anyone looking at this to think that there’s no transaction cost they’re gonna be they’re gonna pick this right 50 stocks every month boom like yeah right now but again more art less science we look at this and we’re like well okay this is cool on paper but there’s trading costs right so that’s kind of where why we went here down to the three-month rebalance so i will give you again this is a very deep dive article that i wrote um it’s called factor investing and trading costs and one thing i will highlight is you know so wes and i uh have phds so we do actually still write academic papers so i can read any academic paper and understand it but we’re also practitioners right and so there’s this actually huge debate um amongst academics and practitioners specifically about do trading costs destroy the momentum anomaly and what i would say is that there is not a definitive answer here right because um for example um you know practitioner data right says that momentum can have you know 65 billion dollars in it whereas practitioner whereas academic data says it can have 5 billion right so we’re talking like 10 times the ten times on one thing and actually uh you know that’s just for one measure right um and let’s do if you do over five days they say that momentum can have 324 uh million right or sorry billion right so 324 billion practitioner data from uh from you know basically andrew rang who’s at blackrock right so blackrock’s telling you 324 billion the academics are telling you five billion right you’re like well that’s like that’s a vast difference right it’s like it’s it’s crazy and again remember it’s also not within a uh you know you have to have a billion in and everyone running the exact same strategy the exact same time which not is the case right but so there’s this huge debate and then one thing you can say is well hey why is it possible that academic database or the academic thing says 5 billion and the practitioners says 300 billion right you’re like this just doesn’t make sense right and so there’s a really cool paper uh by aqr in addition to that andrew ang uh blackrock paper andreas actually a very good researcher as well but you just have this work for blackrock and what they looked at is this is so when i showed you the academic returns they said five million but then what what aqr went and did is they said hey let’s look at what the academics says it costs to trade the s p 500 right like what does it cost to do this to rebalance the fund right like this week tesla was not added right so they’re doing their rebalance soon but what is the cost so academics say it’s like 65 basis points whereas ishares vanguard and the practitioner datas says like well below almost like 10 times lower so that’s a long answer to a short question of what about trading costs right and actually this article keeps going on further and further and further but trading costs will definitely eat into a momentum approach but in my opinion i don’t believe that it destroys the anomaly so um but obviously you guys are a educational firm and this is literally a 10 000 word article i wrote um actually showing and talking about both sides of the argument so i will pass along this article if anyone wants to do a deep dive into it uh but that that’s the long the i would say five minute answer to what about trading costs that’s great we’ll include the paper in our show notes um and just to be clear so i’m seeing a couple questions here uh asking about zero dollar brokerage commissions and i just want to point out and feel free to add to it that we’re not talking just about commissions uh but differences like the difference between a bid ask spread what buyers and sellers are paying um and also if your trade moves to stock and obviously with an individual investor in a well-traded stock it’s not as big an issue as it is for institutional investor but still a potential cost that’s correct yeah the actually so great question um the majority of costs for larger investors which is really what the papers are examining um but the larger trading cost has nothing to do with like your you know 599 brokerage or now it’s like zero right but it but it really has to do with your market impact and the bid ask like do you actually move the stock um and you know as you know you know zero commission is cool but you know there’s a reason that firms are still doing zero commission because you know they’re they’re selling those trades to hft firms um to make some small small amount of money probably less than what they were charging before but definitely making some money so great thanks jack i’ll let you get back to the presentation and to the audience i’ll continue to monitor the questions perfect so again this is just trying to highlight why we picked 50 stocks in every three months right there’s no perfect answer uh we thought it was a good trade-off of less turnover less trading costs and you know we wanted to have more concentrated portfolio so you know we run uh u.s and international indices you can find more information about them on our website and so you know one question we commonly get is well hey like you know you have these indices in the u.s right so the u.s is blue uh the international is yellow a common question is well hey what does that look like like how does that compare on you know certain metrics compared to like the market and so what this does is it looks at uh two things so this is called market cap just billions what you notice is since we equal weight our portfolios they generally have a small size tilt right so this is the s p market cap ours is you know one-fifth of it and here’s the ife market cap we’re about you know one third of it right now not surprisingly if we look and we look at the momentum characteristic of all of the underlying uh positions within our index it happens to be you know more positive here because literally this is the main variable that we sort of so kind of not surprising that the stocks here had better prior returns in market in the us same internationally right and as i mentioned before uh our indices have higher active share um and all this again is highlighting is that it’s just going to be wildly different than the market okay this is a way to visualize what we own in the portfolio so the gray dots represent all the stocks in the russell 1000 ranked on either sides on the y-axis or momentum on the x-axis and so whenever you actually would go and rebalance the index you would actually be oops uh looking only at the firms in the top 10 percent right and the blue dots for our u.s index are bigger because we equal weight the positions whereas you know some of these mid cap stocks have very little weight um so this is a a new tool that’s kind of actually we’re not complete with it but it’s called visual active share basically shows you not only how different are you than the market but what are you actually allocating towards so i want to get through uh these couple slides and then we’ll go to questions right so i have five slides left so one thing i would say is hey this is cool we build this momentum index and it’s definitely different than the market now what are some of the downsides of building different portfolios so as i showed you before you know vanguard kind of rebuilt just a very portfolio that’s value but it’s very close to the market and when you rebuild a portfolio that’s very close to the market you get returns not surprisingly that are close to the market right so here’s like two simple examples of being different than the market so the first is just you know the warren buffett example um and this was back in uh 2000 right and we you know just facilities facetiously put a uh quote here you know tech is mispriced have fun losers and then you know warren buffett saying charlie should we buy tech and we put that there because over this you know i think it was eight month time period right berkshire hathaway was down 40 percent when the nasdaq was up 110 so he lost by a hundred and fifty percent relative to something that anyone could go out and buy very easily right and barons even had an article said warren buffett may be losing his magic touch now obviously you know the next 15 years it kind of flipped recently though he’s underperformed again so again when you build a portfolio that’s different than the market or different than another index you’re going to have different returns right so here’s the second one so this again is going on uh ken french’s website and looking at the top decile of moment right so this was this chart up here sorry i know i’m skipping around but that was this chart so when you look at this chart you’re like well i would always want this chart right but when you look at it over a five year period and compare it to the market you see that there’s multiple times that you underperform by like five percent annualized right five percent compounded is like thirty percent so you lost by thirty percent here here here here here here here lost by a little here here’s like seven percent right seven percent annualized over five years like 40 plus percent right so when you build these portfolios that are different the caveat is it’s not going to work all the time right and obviously we can’t guarantee it’s going to work in the future you have to kind of think that this is going to be a factor that will but this is just highlighting one of the downsides of building different portfolios and so we say you know factors work for a reason they can’t work all the time and so essentially you know that’s kind of what we do in our indices and what we outline in the book is we we build things that are differentiated right they have high concentration to momentum and you know we we hope that they’re going to have extra return but we can’t obviously guarantee anything right whereas the path of index is just going to give you the returns of index um and so yeah that’s the general overview so i’ll stop there and uh charles i’ll let you chime in with additional questions thanks jack um a couple questions here while i try to get my camera back on um someone asked um why does momentum work and another person uh actually asked um why does it continue to work yeah yeah so they’re uh i would say similar quite almost like the same question like like why does it work um so so and you know academics have looked at it um there’s it just similar to um other factors they kind of argue over whether it’s like a behavioral effect or a risk effect so on the wrist side um you know there’s a couple of papers looking at that but the main the main papers within for momentum have to deal with the behavioral effect and it has to do with investors kind of actually under reacting to news right so value investing generally is thought to work from a behavioral standpoint due to overreaction with the overreaction being people just think that the company is going to go bankrupt right and you think the company’s going to go bankrupt and then it has a good turnaround story and alternatively growth stocks people think they’re going to always win and then they end up doing poorly so for momentum why does this work it works for the opposite effect whereby investors actually under react information right so on the winning side like winners maybe like good news comes out about a stock and the stock kind of goes up but it doesn’t pop up like enough like it actually should have went further so then in the future it just continues to drift up as people like really understand the good news and the same thing happens on the bad side right like maybe some bad news comes out about a firm and the market doesn’t actually goes down but doesn’t properly adjust down so the main behavioral effect has to do with uh i would say under reaction to information um and then you know why would you think it would work in the future well if you believe that’s an effect and you believe that that’s going to happen in the future that that’s a uh one side of the behavioral financing is you need to know you know what’s the error that investors are making and then the second thing is um you have to also know why people won’t do this right well here’s like one reason why people may not do it like tons of every institutional investor right imagine being on a board going to uh you know going being the cio going to report to a board of trustees and saying hey guys listen we had this momentum strategy and by the way we lost by 40 percent and 40 over the past five years relative to the market right like good luck that’s just that’s just not gonna happen right so i believe that there’s the the you know limits to arbitrage is investors can’t not every investor can actually do this right like individuals kind of have an advantage because as long as they don’t compare themselves to this to the market you know they they can maybe live through some of these drawdowns that these these are relative drawdowns that these factor portfolios have so hopefully that answers both it does um now question uh someone asked whether or not it’s tied to growth another member asked later on right now obviously growth is doing better than value what happens when value takes over how does that affect the momentum uh factor yeah so good question so uh in our book we specifically looked and examined and tested what is the overlap of growth stocks with high momentum stocks and we found it to be about 20 right which is actually surprising right you would think that high momentum stocks would be gross stocks but actually historically when you look at it uh and again the exact details are in the book um we found it was only 20 so momentum is definitely different than growth in us which is good because um you know it’s it’s a different exposure now when value turns around this is one of the reasons you know i personally always like momentum momentum is uh and i’ll give eric balconus credit for calling it a chameleon right momentum is a factor that’s going to change its characteristic in different environments so let’s say value investing starts doing well right let’s say that for example say you know well let’s go back to like the 1999 internet bubble right so what happened there right momentum did awesome there’s all these like uh internet type companies right like cisco’s of the world and they did really well going in tonight to the end of 1999 but then it flipped right and so what happened was values tended to do better well there’s going to be that this period of time when actually the value stocks for some period might actually become high momentum right because all it’s going to do is compare past years or terms so let’s just say that for example say the top you know 20 largest firms in the u.s which are high momentum happen to now just be down 20 over the next year maybe not for any reason other than people think that they were overvalued right so they’re negative 20 and maybe you know consumer discretionary is up 20 well now you’re going to be buying value stocks within momentum and then as that maybe transitions you you might you’ll probably transition away from value but momentum will actually transition itself because all you do is you’re always just going to be rebalancing into the firms that have done the best which can at times actually be value great uh someone’s actually referring to last week’s webinar with larry uh where larry suggested combining uh factors uh versus relying on more than just instead of relying on one factor uh could you comment on it and perhaps uh give some suggestions about what momentum might be paired with yes so larry is very uh correct in pointing out that using multiple factors makes sense right because not only it’s it’s similar to combining stocks right when you combine stocks you can reduce some of the idiosyncratic risk of individual stocks when you combine factors you can reduce some of the noise or the you know the idiosyncratic risk of just a factor right like this is idiosyncratic risk losing by seven percent over five years right um so by combining them you can reduce this and get a smoother path which is what everyone likes to do higher returns with less volatility so larry’s correct uh what i would say is and i will pass along this article it’s you know i would say that combining value and momentum in my opinion are the two best factors that work well together the biggest reason being is value and momentum when you look at long short portfolios are negatively correlated what that means is when momentum does well value tends to do not as well and they’ll flip but they both actually have positive premiums so definitely combine it with value is what i would say and i will pass along those two articles about why you should do it but also how you should do it great thanks and we’ll include those into show notes a few members have asked about using it momentum on an industry or sector basis perhaps using etfs to do the rotation instead of individual stocks yeah so there’s academic papers that have exact in that and that tends to work right you can do industry momentum uh sector momentum and that actually does tend to work so uh there’s uh i would i would say there’s nothing uh that i would say that’s against that uh it’s definitely a way you could do it we actually prefer to just use the individual stocks but you could do it and then we had one member ask about just turnover um his comment was well momentum stocks keep winning and loser stocks keep losing how long does that happen where you have the same stocks continuously passing uh versus there’s a change so the turnover is going to be a lot higher uh like if you look uh you can look in annual reports uh for you know some momentum funds that are out there you’re going to see higher turnover um within momentum funds so yeah but turnover is a large um piece of the momentum puzzle and unfortunately you do have to deal with that so it’s you’re going to have a lot more turnover for momentum relative to value i hope that answers that question uh what about uh smaller companies uh since you know a lot of our members they can go a lot smaller than the institutional investors how does momentum work on that regards works really well in small cap stocks um and uh there’s a let me say i’ll pull it up so you know we’ve studied this internally but i’ll uh give you your credit for here’s a paper called fact fiction and momentum investing right and specifically one of the questions that they ask and answer directly in this paper right i mean we’ve tested this ourself is hey how does momentum work in small mid large cap stocks right and so what you find is here’s the returns oops let me zoom in so everyone can say it the returns for momentum for small stocks big stocks and this is umd combines these two and what you notice is that small generally did better than big stocks so short answer is momentum from a long short perspective does better within small cap stocks now for your members who may be thinking about using that information they i would caveat it with this while this is true it works better long short for small relative to large you are still taking small cap tilts right so you know if anyone has invested at all in the us over the past five years you’ve seen the market and mega caps do much better than small caps right so you know it works within small cap stocks but you are still taking a small cap tilt great and uh just one last question a couple people have asked about trading i’ve seen a couple questions regarding momentum and technical analysis and how they work or how they might differ um if you could just comment i guess i’ll you know obviously goes trinkets to turn over how frequently you should turn over and then obviously a technical analysis how’s momentum relate to that yeah so momentum is related to technical analysis right it’s just a way to uh this is one way to measure is what i would say um it’s not trend following right so when i talk about momentum it’s not like get out if it’s doing bad this is just looking at comparing stocks and picking the winners right even if the winners happen to be the losers like happened to have a negative return over the past year right um and then on trading uh yeah so what was the question on trading again i think the question is asking actually this person asked about uh about day trading within roth iras and i have had some people ask me you know about what’s history momentum and you know frequent trading short-term trading and how does that differ yeah um i mean day trading in my opinion is just different than investing i i would view this as a long-term investing strategy that’s just a systematic process day trading again i have nothing against day trading it’s just it’s different than long-term investing um and obviously though day trading you probably are going to use momentum signals in there i don’t have uh like i haven’t looked at you know short term within intraday data to be able i would say fully answer that question and actually i’ll get one other uh i’ve been asked about what the actual real life performance is um i say i know you have an etf tied to momentum uh if people wanted to see how your how your funds have actually performed in real environment uh where can they see the performance yeah so um yeah on our website it’s uh alfarchnik.com we do have a link to the etf site where all the information can be found there great thanks jack so much for joining us um thanks everybody for attending uh ryan i think you’ll uh chime in about what we have for upcoming webinars i do and i i wanted to thank uh jack and uh charles for their time tonight uh let me just share myself thank you thank you for having me on yeah it was great it was great uh great talk um thank you jack one second i believe i am showing my screen can everybody see that okay yes right um so i just want to remind every uh folks that a replay of the presentation will be available uh tomorrow on our youtube channel along uh with uh many of the links that jack talked about uh tonight’s handout and to some of the resources um these will be sent to your email address since you did register uh we do have some upcoming webinars to highlight which you can sign up for as it says on the screen uh www.aai.com webinars we typically broadcast uh every wednesday night um at 7 30 central uh next week we have aai’s own wayne thorpe who’s uh talking about investing like a stock superstar a fundamental and technical approach to seeking growth stocks that i believe he’s uh talking about the next group in the ssr portfolio that’ll be uh next wednesday uh the following week uh we’ll be joined by paul merriman uh and his uh webinar is entitled on which is the best one two three and four fun strategy don’t wanna miss that that is september 23rd and then the following week on september 30th uh charles will be uh speaking uh giving us an update on the aaiway project i won’t want to uh we want to tune in to all these webinars again these are free uh we love doing these we love putting these on and we love uh educating folks about investment so uh with all that said uh we want to uh thank everybody for participating and we wish you good health and good wealth good night good night thanks