Is the concept of momentum and trend trading flawed?

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Old Jul 15, 2017, 8:41pm   #1
Joined Jul 2015
Is the concept of momentum and trend trading flawed?

Recently I have been trying to come up with some new systems. When I do this, I often need to quantify concepts. My general thinking of stocks and how price behaves has been for a while now that: A stock that is going up is more likely to continue going up than change directions. The simple reason behind this being that the stock is "trending" and "has momentum". At face value, at least to me, this makes sense. I recently decided to put it to the test though to see if anything can really be gained from trading this way.

I tested this by doing the following:
If a stock has had "x" up days (as defined by an intraday close - open gain) in a row, the stock would be bought the next day at open and sold at close.

I varied "x" from 1 to 10. Obviously in the lower range, I don't think anyone would conclude a stock has momentum or was trending. In the upper range however, this would be the conclusion that I would make. So, my expectation was that in the lower range of "x" values, I would have about a 50/50 win/loss rate, but I figured that if the concepts of momentum and trend truly offer any edge towards trading, I would see at least a marginally higher win percentage with higher "x" values.

I tested this over a 2 year lookback period (7/13/15 to 7/13/17) on 1,430 symbols (~20% of tradeable symbols I have access to). The results are as follows:

momentum.png

The first column (up days in a row) represents "x". The margin of error based on a 99% probability was calculated as well and is in the last column. From this though it seems pretty clear to me that there is essentially no meaningful edge to be gained from trading with the "trend" or trading when "momentum" occurs. This result distribution would be in line with what would be expected from a pure unbiased coin toss sample.

Anyone have any thoughts?
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Old Jul 15, 2017, 8:53pm   #2
 
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Quote:
Originally Posted by Dr. Toad View Post
Recently I have been trying to come up with some new systems. When I do this, I often need to quantify concepts. My general thinking of stocks and how price behaves has been for a while now that: A stock that is going up is more likely to continue going up than change directions. The simple reason behind this being that the stock is "trending" and "has momentum". At face value, at least to me, this makes sense. I recently decided to put it to the test though to see if anything can really be gained from trading this way.

I tested this by doing the following:
If a stock has had "x" up days (as defined by an intraday close - open gain) in a row, the stock would be bought the next day at open and sold at close.

I varied "x" from 1 to 10. Obviously in the lower range, I don't think anyone would conclude a stock has momentum or was trending. In the upper range however, this would be the conclusion that I would make. So, my expectation was that in the lower range of "x" values, I would have about a 50/50 win/loss rate, but I figured that if the concepts of momentum and trend truly offer any edge towards trading, I would see at least a marginally higher win percentage with higher "x" values.

I tested this over a 2 year lookback period (7/13/15 to 7/13/17) on 1,430 symbols (~20% of tradeable symbols I have access to). The results are as follows:

Attachment 243058

The first column (up days in a row) represents "x". The margin of error based on a 99% probability was calculated as well and is in the last column. From this though it seems pretty clear to me that there is essentially no meaningful edge to be gained from trading with the "trend" or trading when "momentum" occurs. This result distribution would be in line with what would be expected from a pure unbiased coin toss sample.

Anyone have any thoughts?
There maybe more of an edge if you added the parameter of a breakout past previous highs (13, 26 or 52 wk)
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Old Jul 15, 2017, 9:23pm   #3
 
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Quote:
Originally Posted by Dr. Toad View Post
Recently I have been trying to come up with some new systems. When I do this, I often need to quantify concepts. My general thinking of stocks and how price behaves has been for a while now that: A stock that is going up is more likely to continue going up than change directions. The simple reason behind this being that the stock is "trending" and "has momentum". At face value, at least to me, this makes sense. I recently decided to put it to the test though to see if anything can really be gained from trading this way.

I tested this by doing the following:
If a stock has had "x" up days (as defined by an intraday close - open gain) in a row, the stock would be bought the next day at open and sold at close.

I varied "x" from 1 to 10. Obviously in the lower range, I don't think anyone would conclude a stock has momentum or was trending. In the upper range however, this would be the conclusion that I would make. So, my expectation was that in the lower range of "x" values, I would have about a 50/50 win/loss rate, but I figured that if the concepts of momentum and trend truly offer any edge towards trading, I would see at least a marginally higher win percentage with higher "x" values.

I tested this over a 2 year lookback period (7/13/15 to 7/13/17) on 1,430 symbols (~20% of tradeable symbols I have access to). The results are as follows:

Attachment 243058

The first column (up days in a row) represents "x". The margin of error based on a 99% probability was calculated as well and is in the last column. From this though it seems pretty clear to me that there is essentially no meaningful edge to be gained from trading with the "trend" or trading when "momentum" occurs. This result distribution would be in line with what would be expected from a pure unbiased coin toss sample.

Anyone have any thoughts?
to add to cbrads comment, i have backtested systems of a break of 52week highs with 70% success rates across the entire FTSE going back 15 years. Trend trading does work, with a significant edge
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Old Jul 15, 2017, 9:33pm   #4
 
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Also if you could define a stop loss level in terms of recent price action, eg. Previous closes, lows, medians, highs etc. then the successful trade's gain could be evaluated in R:R terms and a 50% win rate could still make you money
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Old Jul 15, 2017, 10:05pm   #5
 
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52% took us out of Europe so if it doesn't represent an edge we're in trouble

Price doesn't often go straight up without any pullback which is perhaps indicated by the steep fall off in the number of trades as the number of consecutive ups increases. To test the trend it seems to me that you have to cater for temporary pullbacks in some fashion. Quite how I leave to you to wrestle with
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Old Jul 15, 2017, 11:14pm   #6
 
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If I am understanding your post correctly, in part at least, you are dealing with the concept of probability. Prior to when you start counting your number of 'up days' you are not paying any attention to what has happened prior to day 1 in terms of determining whether the stock price is in any kind of trend.

Given that on any given day a stock price can go up, stay the same, or go down. With equal weighting of probability, the chance a stock will go up in price is 33%. So if you have calculated that by using your method you can achieve 50%+ wins, then that is pretty good?

As you are aware Im sure, Trend and Momentum do not necessarily occur together. Trend being the direction, Momentum being the speed, while importantly the other part of the equation, in my opinion, is Gravity, hence the likes of consolidation periods, and pullbacks. I think the idea you have is one where the price keeps going up the longer its been going up, whereas if you think of the stock price as a bouncing ball (its the best I can come up with at this time of night...) If you bounce the ball away from you hard onto the floor, it rises up, quickly at first, but then tapers off as gravity takes a hold, before hitting the ground and taking off again in an upward direction etc....The longer its up in the air the less likely it is for it to continue being up in the air without coming down.

A coin as we know has no memory, so statistically it can be flipped for years constantly and each outcome is totally independent of any prior or subsequent outcomes. Something that was touched on in one of the threads earlier this week however, is conditional probablility. I think this may well come into play here because for each additional day the price goes up, the likelyhood of it going up again the following day decreases, as I have just suggested above. This can Im sure be demonstrated statistically, but also consider that unlike the coin flip, sentiment, psychology and a whole load of other factors come in to play with stock prices.

Looking at your thoughts again in your 3rd paragraph. I can see where you are coming from, that each additional day the price goes up is going to confirm a trend. I think your edge, which is seemingly backed up by your spreadsheet is gained by buying a stock that has had the fewer number of updays. Your only consideration is how to screen and choose which ones to buy, which leaves me thinking about stocks for instance that are making new highs? i.e a stock that has gone up in price for one day only, but has also made a new high. Another round of testing maybe...?

Last edited by IceMan; Jul 15, 2017 at 11:17pm. Reason: Grammar
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Old Jul 16, 2017, 8:46am   #7
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Wouldn't you consider trend as a longer term thing, i.e. not just the next day/bar. If the trend is up, I wouldn't necessarily think we'll be up on the next day, but maybe up 20 days from now.

Also it's worth thinking that something can be up 50% and down 50% of the time, and still be trending upwards. There is the extent of the move.

Is there overlap in your results? For the case that there were 10 days up and the next was up, does this count as 2 successes for the 9 days in a row system, 3 successes for the 8 days in a row etc.
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Old Jul 16, 2017, 10:19am   #8
 
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Originally Posted by seekingTruth16 View Post
Wouldn't you consider trend as a longer term thing, i.e. not just the next day/bar. If the trend is up, I wouldn't necessarily think we'll be up on the next day, but maybe up 20 days from now.

Also it's worth thinking that something can be up 50% and down 50% of the time, and still be trending upwards. There is the extent of the move.

Is there overlap in your results? For the case that there were 10 days up and the next was up, does this count as 2 successes for the 9 days in a row system, 3 successes for the 8 days in a row etc.
There could be some importance to this very point but I will leave that to you to test.
For instance if the move is growing then the likelyhood is of continuing and conversely if the move is getting smaller then it is likely to reverse.
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