DIY Momentum QnA and Discussion

After a long period of research, I have not found any discernible evidence that technical analysis significantly enhances the performance of momentum strategies. It’s important to be aware that technical analysis is of two types:

• Technical Indicators: These are reasonably systematic and include RSI, moving average, exponential moving average, etc. These are tested thoroughly, and we already use basic ones like moving average, or within some percentage from an all-time high, etc. These work. I haven’t seen anything that enhances performance more, like RSI or donchain channels or similar indicators. The more indicators we add to the momentum strategy, the higher the probability of having a false positive breakout or false positive exits. Churn increases, and returns go down because you constantly enter and exit. In my backtesting, I observed that keeping the core filters like moving average and all-time high, analogous to momentum, is acceptable. Anything else derates the strategy performance

• Technical Chart Patterns—These are discretionary and almost impossible to backtest, so I don’t know how these patterns will enhance or derate the strategy’s performance.

Now, to “whether we should use technical analysis or not?”

The answer is that “it depends” – the traditional momentum factor in academia doesn’t have a moving average filter, nor does it go into cash. But most of us do that to enhance our strategies, and we have found that it has worked historically in our markets. Now, for technical analysis, if you have tested it or are confident that it will increase your performance and help you stick with the strategy, plus make you more comfortable, please go ahead and use it. The only thing to remember is that every technical indicator or chart pattern, or extra filter you add will have a trade-off. If you try to reduce the drawdown to a lower extent, you will lose on cagr. There is no holy grail.

While I follow my systematic strategy according to the rules I have set for myself, I also understand that to make money in markets, having multiple uncorrelated strategies is a must. This diversification ensures that you can stick to the rules and not get bogged down if one strategy is in deep drawdown during the current market regime. It’s a safety net that provides security and preparedness.