This is Part VI of the Dynamic Momentum Trading series on how momentum rankings may be used to trade ETFs. It is important that the reader understand the previous posts. They can be found by beginning at Part I or by looking under the Investing selection of the main menu on this site.
The purpose of this post is to show how the numerous options in the DMS system can be eliminated without reducing the efficacy of the system.
The trading model presented thus far was established with options for testing purposes. Often critical variables can be identified but not their importance over different value ranges. The number of positions to be traded and the trading styles were two that fell into that category when designing the system.
No amount of a priori reasoning can answer how important either might be over various ranges, especially when placed into a particular model. Their own specific constructs and the constructs of a mathematical model that purports to measure the effects of current momentum on future value make such a task impossible. However, when theory cannot provide answers, empirics may.
The two variables in question are the following:
Trading Styles: Three trading styles were built into the momentum algorithm. These were Normal, Aggressive and Conservative. Number of Positions: The number of ETFs that could be traded ranged from 1 to 3. The empirics provided by extensive backtesting already performed allows reasonable answers as to the right range of values for these variables.
This post was published at Economic Noise on January 2, 2017.