Saturday, May 30, 2015

Dow Theory Special Issue: Dual Momentum versus Dow Theory

Trends remain unchanged

I have compared in the past the Dow Theory versus moving averages. Let's compare now the Dow Theory and Dual Momentum.

This post is the edited correspondence with one follower of this Dow Theory blog.

He, like I, has read the book "Dual Momentum Investing", by Gary Antonacci. 

By the way, I wrote a laudatory review of his book here.

 I was asked whether dual momentum, as expounded by Antonacci was even better than the Dow Theory, since Dual Momentum boasts an annual return of 17.43%.

What follows is my answer with some more "meat" I have added during the writing of this post.

Antonacci’s dual momentum seems to have a máximum drawdown of -22.72% (page 102) (with a lookback period from 1974).

Schannep’s Dow Theory has had a lower drawdown (I don’t have here the exact figure) (with a lookback period from 1956). I suggest you go back to this page, in order to fully understand why Schannep’s drawdowns are well contained and likely not to get out of hand in the future.

The longer the lookback period, the more realistic the maximum drawdown. However, always bearing in mind that the worst drawdown in our career lies ahead. Thus, I find more credible Schannep's drawdowns (due to a longer lookback period) than those of Dual Momentum. I am not implying that dual momentum is a bad strategy, since I have written in the past that if I forgot all I know about the Dow Theory, I would immediatly make dual momentum my investing strategy of choice.

The average “loss from entry point” (be it actual –losing trade- or potential) with Schannep tends to be around 4-8%, which is quite narrow. If we had 3-4 losing trades in a row we could match Antonnaci’s drawdown. This has not happened yet, but it can certainly happen when looking forward. But such a bad luck (string of losing trades, or death by a thousand cuts), could also afflict Antonnaci, as it affects all who don't stick to "buy and hold". However, Schannep’s Dow Theory has a quirk (to be explained in the future, if I find time and focus) which makes such scenario a very unlikely event.

There is another thing that makes me more comfortable with just the Dow Theory. It has nothing to do with technical analysis. In my blog I have writtten several times that, even though, I am a technical guy, I have eyes to see and a brain to thing. Personally, and I can be “fundamentally” wrong, I distrust bonds, t-bills (yes, what if one day the USD goes under or there is a reset; look what happened to the EUR/CHF some days ago). So, on the eve of a big reset, stocks could show less momentum than bonds (first deflation, then, suddenly, high inflation), and following Antonacci, one should be in bonds. All in all, I don’t like debt, I like equity, and, as an insurance with optionality, physical gold. While all this is “fundamental”, I feel more comfortable “trading technically” with a system (Dow Theory) focused on equities and avoid debt instruments.

During Weimar (Germany) hyperinflation, debt was destroyed. Equities hold some ground (even though they lost real value), and gold and USD made real purchasing power gains.

So, under the current economic environment I distrust all kinds of debt (be it USD, EUR o JPY denominated).  If I don’t want to touch debt, then Antonacci’s system becomes somewhat maimed.

As to physical gold, this is a very personal decision.

As to equities, I feel comfortable with the Dow Theory. Having said this, if I didn't know the Dow Theory, I'd find Antonacci's Dual Momentum the best technical strategy to follow (for trades with a time horizon of ca. 1 year). So, I find Antonacci's strategy very sound. 

Furthermore, there are some ways to increase the basic performance of the Dow Theory and aim for dual momentum returns. Instead of buying the indices, if you just buy high relative strength stocks when a primary bull market is signaled and sell them when a primary bear market is signaled, you tend to make much more than by merely buying the SPY. However, you get more of a roller coaster. Of couse, this strategy can be improved (and has been improved) but even the basic version works well. 

Another way to try to add an additional 3-4% annual performance to the Dow Theory would be buying stocks with positive insider buying ratings. I am in the early stages of this research but preliminary I think that coupling stocks with good insider buying when a primary bull market signal is flashed and selling them when a primary bear market is signaled is a sensible way to aim for greater returns with a very limited risk (as such stocks tend to have lower draw downs unlike high relative strength stocks). The best book I have read, which contains in-depth research, concerning insider buying is "Investment Strategy for Insider Trading". Read the book and start exploring coupling such stocks with a Dow Theory filter, and relax.


The Dow  Theorist

No comments:

Post a Comment