What is Momentum?


Momentum is one of the strongest, if not the strongest, of the major market ‘anomalies’ documented in the literature
— Cliff Asness, Founder, AQR Capital Management
Momentum is the biggest embarrassment for Efficient Markets [Hypothesis]. I hope it goes away
— Eugene Fama, Nobel Laureate, Founder of Efficient Markets Hypothesis

Momentum is an investment strategy that buys or sells based on recent price trends, buying the assets rising in value and selling those that are losing value

By doing so momentum strategy (also called trend-following) seeks to achieve higher risk-adjusted returns than simply buying and holding assets. This is an 'anomaly' since such strategies must not exist in an efficient market

There are decades of evidence confirming 'momentum' factor, and various explanations for its existence such as prices' impact on sentiment and behaviour

 


 
 

Momentum in Cryptocurrencies

 

Cryptocurrencies are uniquely well-suited for a systematic momentum strategy for  several reasons:

 

1- Cryptocurrencıes lack "gravıtatıonal pull" from fundamental drıvers of value, potentıally gıvıng them a hıgher tendency for boom/bust cycles

 

  • Similar to commodities (e.g. oil, gold, iron), cryptocurrencies have no cashflows of their own, making valuation methods like discounted cashflows irrelevant.
  • However, unlike commodities, they also do not have a "cost of extraction/production" to regulate supply/demand imbalances. For example, bitcoin price is completely decoupled from mining costs: Regardless of how much or little capital is spent mining bitcoins, algorithm ensures there will be one block per 10 minutes, and no more than 21 million bitcoins. A 100x increase in demand cannot increase supply by even 1%. 
  • With no "center of gravity" cryptocurrencies can exhibit more momentum than other asset classes, with more propensity for boom/bust cycles.

 

2- cryptocurrency markets are domınated by retaıl ınvestors, and hence contaın more ıneffıcıencıes

 

  • Algorithmic trading strategies fundamentally capture market inefficiencies created by unsophisticated participants.
  • For a range of reasons (e.g. lack of institutional grade custody), institutional investors are currently underrepresented in cryptocurrency markets, making them more inefficient.
  • Even in relatively efficient markets like equities and rates, momentum is still not fully arbitraged away and remains a core strategy for quant funds. In an emerging asset class like cryptocurrencies, we expect momentum to remain un-arbitraged and a scalable source of alpha for investors.

 

3- cryptocurrency markets move fast, both ın prıce and technology. prıce trends could ıdentıfy future wınners early

 

  • Many tokens compete for similar use-cases such as store of value, private payments, and smart contracts. It is difficult for any investor to remain on top of developments.
  • If an "altcoin" achieves bitcoin's functionality more successfully (e.g. less fees, more security), altcoin can rise in adoption and price at bitcoin's expense. A systematic momentum strategy would respond appropriately by selling bitcoin and buying the altcoin, only using price signals as its input.
  • One limitation to this is the current high correlation of cryptoassets. Virtually all tokens rise and fall in tandem, reducing diversification benefits. On the flip side, this increases the benefit of downside protection inherent in momentum strategies.

 

 

How It Works

 

Our momentum trading framework has three core components

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1 - FORECAST CALCULATION

This is the core function that decides how strong the momentum is for a given asset.

It uses momentum rules, spread across different time windows (i.e. variations), which is combined to 'span' the potential windows where momentum can exist.

Core Task: Systematically identifying trends across hundreds of cryptocurrencies, diversifying across time scale and currency, which improve Sharpe ratio.


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2- volatılıty targetıng

Volatility Targeting framework decides how much maximum capital should be allocated per currency, to ensure risk is at desired level.

This is important to make sure trading is not run with too much risk: i.e. suboptimal from a Kelly Criterion perspective.

Core Task: Ensuring strategy targets an adequate level of risk, maximizing returns while remaining compliant with Kelly Criterion.


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3- Smart EXECUTION

Executing trades with least possible cost is critical to improve returns, especially for active strategies such as momentum.

Lower costs allows running faster momentum trading, hence "spanning" more of the potential trends. It also allows trading less liquid currencies, increasing diversification, improving risk-adjusted returns.

Core Task: Reduce execution costs, enabling trading across more pairs, which improve Sharpe ratio.



 
 

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