Collin Seow is author of “The Systematic Trader: How I turned a $250,000 debt into profits through stock trading.” He also is a qualified Chartered Portfolio Manager with a Certified Financial Technician qualification, and a member of MENSA Singapore and Technical Analysts Society Singapore.
Michael and Collin switch discuss the “Singaporean perspective.” What is the Singaporean perspective and what helped lay the foundation for their success? The founding fathers of Singapore set forth strict rules and regulations so people knew what they could and could not do. The system was laid out clear and concise. Citizens knew what their boundaries were down to the last detail. For example, there are rules defined ranging from whether or not you can chew gum to how far trees are allowed to be planted apart from one another.
Collin moves from the Singaporean perspective socially, to their perspective on trading. More traders in Asia seem to be open to the idea of systematic trading. When he back tests a system, he doesn’t just look at making money, he tries to figure out how to filter out the losses. He wants to protect what he has so the returns will take care of themselves. Picking a certain percent that you’re willing to risk on a trade is not necessarily intuitive. Collin also looks at both position trading and swing trading, and adjusts his risk according to trading style. Although there are many different styles, and factors that play into how one will trade, Collin still attributes over 50% of trading success to having the right psychology.
In this episode of Trend Following Radio:
Different types of momentum trading
Position trading vs. swing trading
A sense of entitlement in today’s society
“At the end of the day it isn’t about having the right strategy, it’s about having the right mindset.” – Collin Seow
“If you don’t have an edge, how the hell are you suppose to play the game?” – Michael Covel
Trend following trading and momentum trading are not the same style. Consider two papers from AQR: 1 (PDF) and 2 (PDF). The terms might imply something similar, but the strategies are wholly different.
There is a vast body of evidence demonstrating that stock returns exhibit momentum — that is, stocks that have done well over the past year tend to continue to do well. And there’s evidence that the momentum premium exists almost everywhere we look, in both U.S. and international stocks (with the notable exception of Japan). There’s also academic research demonstrating that momentum exists in commodity and foreign exchange markets as well. The authors of the 2012 paper, “Momentum in Government-Bond Markets,” studied the period 1987-2011 to determine if momentum existed in these assets. For six countries — Australia, Canada, Germany, Japan, the U.K., and the U.S — they formed long-short portfolios, going long a particular bond maturity if the excess return of the bonds over cash was positive for the previous month and shorting otherwise. For each country they considered three maturity buckets: 1-3 years, 5-7 years and 7-10 years. They subtracted the LIBOR cash return to arrive at the “excess” return. Rebalancing was done monthly. The strategy is easily implementable using highly liquid futures markets. The benchmark is the currency-hedged Citigroup World Government Bond Index. The following is a summary of their findings:
Momentum strategies are profitable, generating annual excess returns over LIBOR of between 0.70 and 2.6 percent, and they do so with low volatility (1 percent to 3.6 percent).
Australia, with the least liquid of the six markets studied, exhibited the lowest returns to momentum strategies. The three most liquid markets — U.S., Japan and Germany –are the best for momentum strategies. Thus, greater liquidity doesn’t seem detrimental to momentum strategies (and trading costs are the lowest in the most liquid markets).
The strategy doesn’t rely on falling interest rates. However, “choppy” markets without direction are detrimental to performance, and returns can be episodic.
The excess profits generated are more than sufficient to cover transactions costs as the government bond markets are very liquid.
Momentum returns are particularly strong during periods of poor performance for credit markets. Thus, momentum strategies provide some diversification benefit against bond strategies that seek exposure to credit (default) risk.
The authors tested the diversification benefits by combining a 20 percent momentum strategy with an 80 percent Barclays Capital U.S. Aggregate Bond Index allocation, with monthly rebalancing. The simulated portfolio generated excess returns of 0.35 percent a year while reducing volatility — the standard deviation fell 0.40 percent. Investors who take credit risk in their bond allocations should consider adding a momentum strategy. This diversification benefited provided by momentum strategies also applies to investors in value stocks. Because momentum is negatively correlated with the value premium, adding momentum to a value-tilted portfolio improves risk-adjusted returns. While there is a logical risk-based explanation for the existence of the stock, small-cap and value-stock premiums, there is none for momentum — only a behavioral story. Yet, despite the fact that there is no risk-based explanation and that the existence of momentum has been known for decades (thus it would seem that it should have been arbitraged away), momentum persists virtually everywhere we look.