Stock rank/Momentum trading ideas

3rd Feb '17 by Investor & Trader

58 comments 17577 reads

I'm looking for a trading strategy and i'm open to opinions and discussion.

My criteria is simply:-

Stock rank >= 90

Momentum >= 95

Spread <=500

Market cap <= 800

Reset every month.

The screener generated 14 stocks on January2nd and generated a 14.7% return in one month.

The average spread was 1.29% leaving a very healthy profit.

All the shares still qualify for February so no transaction costs this month.

My theory is that the high momentum figure will drive the shares in the very short term i.e 30 days. The high stock rank will add some robustness whilst filtering out the weak.

thoughts???

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Investor, Trader and Financial Educator As a long term investor/trader I have consumed hundreds of financial books and endured countless hours of self education. Hopefully my contribution through my channel will reduce the learning curve duration of many aspiring traders by providing the key information in a concise and enjoyable manner. https://www.youtube.com/channe... more »

58 comments

pka

2nd Mar '17

Nick,

I am very interested in your 'risk-adjusted' approach. You wrote in your latest post:

"The "risk-adjusted" aspect tries to minimise volatility so the median and mean performance are closer and the gain is more uniform over the year."

and you wrote in a previous post:

"Using a more conservative way of ranking by momentum (based on my own code)"

Are you willing to provide any more details about your approach?

Nick Ray

2nd Mar '17

Hi pka
Happy to provide more detail about my approach but on my phone at the moment so I'll give a quick explanation and expand later.

Basically I just calculate the Sharpe Ratio based on daily returns SR = (u-r)/s and pick the stocks with the highest values. The problem is that most screeners don't seem to provide Sharpe Ratio data so you tend to have to roll your own.

Ramridge

2nd Mar '17

Hi Nick - as a matter of interest what value do you assume for the risk free rate, r ?

Nick Ray

2nd Mar '17

I usually use the daily rate equivalent of 25% per annum (approx 0.09% per day). I've experimented with other values but provided you have a value in roughly this area you get similar results. Obviously that is higher than a typical interest rate on risk-free assets. But it works more like a "minimum acceptable rate" that you are prepared to accept.

pka

2nd Mar '17

Hi Nick,

Thanks for your reply to my question about your risk-adjusted momentum approach.

You might find the following web page of interest, if you haven't already seen it, because it summarises various approaches to risk-adjusted momentum and gives some references to academic papers on them:

http://www.quantsportal.com/momentum-strategies/

Nick Ray

2nd Mar '17

Thanks pka. So basically I am following what they call the "risk-adjusted momentum" strategy. The equivalent of their "figure 1" for the stocks we have discussed in this thread looks like this using 256-day data:

(You will need to right-click on the diagram and select "View Image" to see a bigger version to read the individual stocks.) It plots the mean return vertically and the volatility horizontally. If you choose momentum without the risk adjustment then generally you prefer stocks which are as high as possible without worrying about where they are horizontally. But when you consider risk as well you want stocks which are on the "efficient frontier" - the outer envelope of the cloud of stocks.

The reason to adjust for risk is this. If you had two stocks A and B with estimated returns of 10% and 20% then you could still use A to get a return of 20% by using 2:1 leverage. So which is the better choice: A with leverage or B? The answer depends on how reliable your estimate of those returns is. If you accept that volatility is a good measure of the "risk" (variability) of the returns, then by dividing each return by the risk you will get a measure of which stock will have the more certain return.

I can't find any stock screener for UK stocks which uses these techniques. Perhaps there is an opportunity going begging for Stockopedia to fill the void here!

However there is a site which seems to provide a very thorough web-based interface to this kind of optimization for US stocks here: Macroaxis (Disclaimer: I don't know anything about that site and I am not explicitly recommending it.)

PhilHofGrowYourDough

2nd Mar '17

I had a look at the macroaxis site and it is so overwhelmingly complex. I might try to do some number crunching on my individual stocks using yahoo finance api to examine my portfolio and future selections

Nick Ray

2nd Mar '17

I had a look at the macroaxis site and it is so overwhelmingly complex.

From their "about us" section :-)

"The Macroaxis financial engineering platform does not need much introduction or walkthrough. We could put together an educational video; but you can make it on your own, really. Just create an account, create a portfolio, then just click around - "simplicity" is what we are all about."

PhilHofGrowYourDough

2nd Mar '17

Haha!

It doesn't help that you are limited to a certain number of screens a day.
So I perused their website to get a feel for the options then went in to analyse something specific and it said "You need to upgrade!"

That sort of thing drives me potty. Let me try it out and let the product sell itself to me and if it's useful I'll pay for it.

Ho hum

Howard Marx

3rd Mar '17

Phil

I think you have asked the key investment question. After all, an investors’ returns tell just half the story. We have to know how much risk an investor took to get those returns before we can judge whether they did a good or a bad job.

Investing involves just one thing
Investing can be said to boil down to one thing: dealing with the future. And to the extent that the future cannot be known with any certainty, it involves risk. Investing is hence an exercise in risk management.

Volatility is not risk
Volatility is the academic’s choice for defining and measuring risk. Things turned out this way because volatility is quantifiable and thus usable in the calculations and models of modern finance theory. However, while volatility is quantifiable it falls far short as the definition of investment risk – after all, what investors fear most is the risk of permanent loss, rather than volatility. Yet such a risk cannot be accurately quantified in advance any more than the chance of rain can be accurately forecast.

It gets worse
Worse than that, you don’t even know AFTER the event how must risk was taken. If you buy shares for £1/each and sell a year later for £2/each, was it a risky decision or not? Some investors would say the profit proves it was safe, while the academic would say it was clearly risky, since the only way to make 100% in a year is by taking a lot of risk. Nobody knows. It may have been a lucky dart throw or a great, safe investment.

Summary
In the long term, high returns can be considered to be attributable to one or more of the following:
• A reward for bearing high risk (this assumes markets are generally ‘efficient’)
• A reward for exploiting a behavioral factor e.g. momentum (this assumes some degree of market inefficiency)
• Genuine stock-picking skill (alpha)

Of course, we can learn little by analyzing short term returns as in short term financial markets, randomness rules – there is no law of small numbers.

PhilHofGrowYourDough

3rd Mar '17

Hi Howard,

I think i have requested that the Guru screen be updated to include Sharpe ratios so that we can get a sense of how risky they typically are.

It's made me laugh before when I've described my 3 year annualised performance (4 years now) on previous threads there were some comments about 'high risk' and 'chasing big risky returns' at which point I provided the x-rayed analysis of my portfolios.

Since switching to a Stockopedia QM screening approach allied with TA my returns have increased and my risk profile has reduced.

I do like the idea of using the Sharpe ratio of potential investments as one of my final selection factors if faced with a few options. At present PEGR is my current differentiator of choice but perhaps a combination of the two will prove effective and will help to reduce drawdowns and the difficult choices around when to sell.

With regard to exploiting behavioural factors I was particularly pleased when I was placing a telephone order earlier today for French small/mid cap injection moulding specialist Plastiques Du Val De Loire SA when the broker questioned "Where do you find these companies?". It was like music to my ears.

I appreciate your comments, it's been an interesting thread all round and when I find time I'm going to start looking at automating the calcualtion of Sharpe ratios on potental stock picks and my portfolios overall.

Cheers
Phil

Rusty2

3rd Mar '17

Hi Phil,

I would also be interested in Sharpe ratios.

You maybe interested to know I have been adding European shares to my portfolio this year, the ones in January are already up about 15%. CE2 is the best performing. I would have bought some more but my broker does not do some online such as Delta Plus, surprisingly PVL is available to trade online. Is there anywhere to get more information on European shares?

PhilHofGrowYourDough

3rd Mar '17

Hi Herbie,

I dont really dig any deeper into the companies background beyond passing my screens and the TA looking good.

I do read the last two quarterly updates and reject any that are negative.
That's as far as much research goes.

Not sure that helps
Phil

PhilHofGrowYourDough

3rd Mar '17

PhilHofGrowYourDough

3rd Mar '17

I've been digging a bit and these set of videos are interesting with respect to the term Efficient Frontier when calculating risk/return profiles and the subsequent videos show you how to tune the weightings of your stock selections to minimise risk and maximise returns ...

Graphing the efficient frontier for a two-stock portfolio in Excel

capital market line and sharpe ratio in excel

I hope you find them useful

Cheers
Phil

Nick Ray

3rd Mar '17

He does quite a good job of explaining the basics in those videos. What websites like Macroaxis do is to automate the process of maximising the Sharpe Ratio of a larger portfolio for you.

I wanted to echo what Howard said though. Volatility is not risk. And also, although these techniques do have validity they are making the assumption that past volatility and return are good estimates of future volatility and return. Often they are reasonable estimates but sometimes they are not. My own experience is that it can be used to sift out a set of good candidate stocks for a portfolio. But when I optimise the proportions of each stock in the portfolio using these techniques I find from backtesting that you can get a rather false sense of precision and accuracy from all the decimal places! So now I tend to take the recommended non-zero-weighted stocks for the portfolio but ultimately use an equal weighting for them. What I do take notice of though is when the optimiser starts allocating a proportion of zero to any stock which previously was a good non-zero-weight candidate.

Modern Portfolio Theory (MPT) suggests that if you just want the best return/volatility ratio from the whole market then you should simply use an index tracker and adjust the return (and risk) by keeping some fraction of your funds in cash or by using leverage. A key corollary of that is that you cannot eliminate all volatility from the portfolio. What remains is the market risk. And as we know, every so often all stocks crash at the same time and there is very little that can protect you when that happens. Market risk is always present.

The other point is that this is a pure technical analysis approach. It does not use quality or value factors when it makes recommendations. I find it a bit concerning that a website like Macroaxis seems to have no fundamental input at all. (If it does I missed it.) If a lot of investors start to use recommendations based entirely on TA without any FA input then they will create bubbles which will eventually implode on them.

Finally, I wanted to ask gpacker whether we are going too far off topic from his original aims for this thread. If so, we should decamp to a new thread to explore risk-adjusted momentum strategies.

Investor & Trader

3rd Mar '17

Hi Nick. Not at all. Interesting reading the thoughts... I'll just keep updating the system as and when for further discussion.
;-)

plank

7th Mar '17

Since this screen is short term and relies heavily on Momentum, do you also use a stop loss?

Investor & Trader

7th Mar '17

My stop loss is any stock that drops below the 50 SMA. Or close all positions if 6 month SMA turns down.

finchy

10th Apr '17

Hi gpacker,

Have you had a chance to update for March's performance?

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