Trend Check with Tushar Chande

Using Momentum ETFs

Momentum ETFs are a useful way to invest in strongly trending markets.  Here momentum is generally measured as a combination of monthly returns over different periods.  Since capitalization is always a concern for the larger ETFs, the larger the capitalization and the stronger the recent price performance, the larger the allocation to the stock.  In general, when market trend strongly, momentum ETFs are expected to do well (see Chart 1).

Chart 1: Momentum ETFs have typically done better than the $SPX as we should expect from their design.


 

A Scan for Momentum ETFs


Here is a scan for momentum ETFs, with SCTR > 70, ranked by their Chande Trend Meter. A broad variety of markets, sectors and capitalization are represented in the table.  Note that the Energy Momentum portfolio tops the list (see Chart 2).

Chart 2: The Energy Momentum Portfolio tops my  CTM ranks of Momentum ETFs

 

Chart 3: The PXI ETF has just broken past a long-term trend-line and poked above key chart resistance.  Observe how previous support became resistance in October.

 

Design Principles: iShares MTUM ETF


The iShares MSCI USA Momentum Factor ETF is largely typical of performance expected in trending markets (see Chart 4).  The methodology of calculating the index is somewhat convoluted, and some of the complexity of the internals is unlikely to alter the rankings and could be eliminated.  However, in simple terms, it responds to 6- and 12-month price returns.  Note that the Fidelity Momentum Factor ETF uses the same underlying index as the MTUM ETF and hence the two are essentially identical in performance.

 

Chart 4: The MTUM Momentum Factor ETF uses equally weighted 6 and 12 month performance (ignoring the most recent month before rebalancing) after normalizing them with annualized standard deviation and adjusting for capitalization. Thus, allocation is sensitive to performance over the past 13 months as well as capitalization, and automatically responds to price action.

 

Using Momentum ETFs

Momentum ETFs are an effective way to take advantage of strong market trends.  For example, emerging markets tend to have a larger effective beta during strong trends in US markets, i.e., they will have a larger up move, as we can see in Chart 1, and is one way to leverage up your investment if you feel the US markets are going to trend strongly.  

You can also use the performance of momentum factor ETFs to understand which return factor is being favored by the market at a given moment.  For example, comparing MTUM to VLUE ETF allows you to compare the relative performance of momentum versus value investing strategies.

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