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Momentum Investing Can Achieve
Market-Beating Returns
By Matthew Tuttle, CFP®
July 5, 2011

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A simple momentum strategy

Every sound trading strategy needs to start with a theory. My theory is that investors should be able to capture momentum in various asset classes to beat the market. To test this, I used five Rydex sector funds: banking, biotech, energy, precious metals and technology.

Every month, I bought the one fund out of those five that had the best performance over the past three months. I could have chosen one, six or 12 months, but I settled on three months because I believed that one month would be too short and that anything longer than three months would miss out on the early part of some large moves.

The next step was to backtest this strategy to see if it worked. I downloaded prices for each of the funds going back to 9/30/1998. I started in 1999, assuming that I would buy the fund that had done the best from 9/30/98 to 1/1/99. Then every month I re-evaluated. If the fund I was currently in was the top three-month performer, I kept it; if not, I sold it and bought the top performer.

Below are the results compared to what the S&P 500 did over the same period:

Year

Momentum Strategy

S&P 500

Outperformance/
Underperformance

1999

10.23%

21.04%

-10.81%

2000

2.96%

-9.10%

12.06%

2001

-5.96%

-11.89%

5.93%

2002

-36.58%

-22.10%

-14.48%

2003

42.28%

28.68%

13.60%

2004

12.03%

10.88%

1.15%

2005

36.94%

4.91%

32.03%

2006

6.26%

15.79%

-9.53%

2007

21.86%

5.49%

16.37%

2008

-46.24%

-38.49%

-7.75%

2009

15.43%

23.45%

-8.02%

2010

42.23%

12.78%

29.45%

Growth of $100,000

$168,837

$118,246



If I put $100,000 into this simple strategy, I would have had over $50,000 more than if I had just bought the S&P 500. (This does not include the impact of any taxes or fees, and it ignores the fact that the S&P 500 is an index, and one cannot invest directly in an index.)

Room for improvement

The results of this strategy are impressive, but there are definitely some areas that could improve. For example, the losses in 2002 and 2008 are substantial. To alleviate this, I could put in a hedging component using moving averages, we could decide not to enter a buy order when a fund is below its 50, 100, or 200 day moving average for example. I could also expand the number of sectors, buy more than one sector at a time, invest in assets in other countries, purchase bonds, test different periods other than three months, etc.

Markets are not efficient or random. They have trends that are identifiable, and investors can use these trends to achieve market-beating returns.


Matthew Tuttle CFP® is CEO of Tuttle Wealth Management and the author of “How Harvard & Yale Beat the Market.” He welcomes your questions and comments and can be reached at 347-852-0548 or .

Nothing in this article should be interpreted to state or imply that past results are an indication of future performance. Please consult your tax or investment advisor before making any investment decisions.

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