The “Problem” with Momentum (or Any Study)

Posted on Dec 18 2014 - 6:32pm by Sharpe Trade

I like quiet markets in which to trade.  Eh … ‘quiet’ may not be the right word.  Perhaps I should say … ‘orderly markets’.  That’s just me, because I’m a directional trader.  Markets that on a time-frame of 12 hours or more, do not zip around as if they are on methamphetamine’s.

In a word, markets that look nothing like the equity markets we’ve had for the last 36 hours.

As you know, I’ve been talking about momentum a lot lately.  Using momentum to measure market moves, and take my directional cues for my outlook.  And herein lay the weakness with using momentum in such a way.

Think about what the word “momentum” means.  Among it’s definitions, it can mean the impetus gained by a moving market.  So when I use momentum, I am using a given ‘velocity’ for lack of a better word, of how a market has moved in a particular direction.  There is an assumption there.  That this ‘impetus’ a market has, will carry it in that same direction.  Naturally, this means that if the market prices begins to zoom around wildly, erraticly outside of the momentum of the measured price that has come before it, a trade or outlook will suffer.

This is logical.  If the market begins to zip and zing around and I’ve been taking my cues from momentum on past prices, then the use of using momentum is going to falter a bit.  At the time of this writing, I am only just now getting my first ‘all-clear’ to go ahead and be bullish on equities.

So what am I left to do?  Should I tweak my approach to the markets?  Does momentum ‘not work’?

If you listen to nothing else I have to say, listen to this.

No.

My method works just fine.

There really is no “problem” with using momentum in the market place.   Thus the quotes in the title of this article around the word ‘problem’.  Like every other study and approach to the markets under the sun, it has it’s ‘downside’.  There is no such thing as a ‘perfect method’.  They do not exist.  Every technical study on this planet is a tool, that looks at prices that have occured in the past, and attempts to measure such past prices in a certain way, so as to provide a particular outlook on the future. And since the markets, on a dime, can become chaotic, a tool may not work as well for a given time-frame. 

This is where many new traders fail.

They see a move that they feel they should have been able to catch if they just ‘fiddled’ with their method, or their approach, and they begin to change their approach.  Or as I like to say, they begin to ‘method hunt’.  Over time, they become obsessed with methods.  Hunting for the ‘perfect tweek’ to a method.  Without realizing a very basic, very simple truth.

The markets are chaotic.

The markets are unpredictable.

There is no perfect method.

It does not exist.

The holy grail of investing and trading, is yes, having a simple method to use, and then having your head on straight, and using money management principles. If your method gives you even the slightest amount of positive expectancy, you can make money over the long term.  There are traders who are 40% accurate, and make lots of money.  There is no ‘problem’.  No ‘problem’ with technical analysis and certainly no ‘problem’ with using momentum studies. This means that you will have losses in profitable trading.   It’s a part of the business.  Your method will lag behind at times.  It’s a part of the business. Recognize the sorts of scenario’s where your particular approach may suffer a bit and why and approach the markets with that knowledge in hand.

Recognize how large the damage typically is in any given situation can be (money management) and learn how to position yourself, so that if it were to occur, your portfolio is not overly damaged.  Myself?  Losses are a part of trading, and if you have positive expectancy over time and try to completely remove losses from your trading, you are bound to fail.

I know that the markets do not always behave as they have for the last 36 hours … they go through long stretches of time where they are more … orderly … and so I move on to the next trade.

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