Momentum Strategy Rules (for my own Portfolio)

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I have received a lot of requests regarding how I build my own momentum portfolio. In this post, I will explain in detail the exact rules of my personal momentum strategy.

Note: While I follow these rules currently, in the future, I may change some filters or other parameters.

Universe of Stocks:

For my portfolio, I use all stocks listed on NSE in the EQ series. Any stock that is in the BE series is ignored.

Total Number of Stocks in Portfolio:

I have a total of 40 stocks in my portfolio.

Anything above or equal to 20 is a good enough number. Below 20 increases the overall volatility of the portfolio as exposure to single stocks increases a lot.

Ranking Methodology:

Here is my ranking methodology:

• The first step is to rank my stocks.

  • Calculate a 12-month sharpe return for each stock

  • Calculate a 6-month sharpe return for each stock

  • calculate a 3-month sharpe return for each stock

  • Then calculate a simple average of the above Sharpe returns

  • Rank all stocks in my universe in descending order of the average of shape returns

• The second step is to add filters. Here is the list of filters that I use:

  • Include only those stocks whose closing price is within 25% of their all-time high price

  • Include only those stocks whose closing price is above 200 day moving average

  • Include only those stocks whose last one-year returns are above the repo rate

  • Include only those stocks whose median daily volume (in rupee terms) for the last year is atleast one crore

  • Exclude stocks that have closed in circuits more than 20 times

• After applying filters, some stocks are excluded, and I get a final list of stocks which are ranked in descending order or the average sharpe returns of 12-month, 6-month, and 3-month

Rebalance & Worst Rank Held:

• I rebalance on the first day of every month. For example, my next rebalance will happen on the 1st of November.

• During rebalance, I exit any stocks that have gone below the 100th rank according to my ranking methodology and filters.

• I replace the sold stocks with new stocks starting from the top of the ranks

• My portfolio never crosses 40 stocks

• I stop buying new stocks once the total number of stocks in my portfolio is 40

Rebalance Time:

• I start my rebalance at 2:30 p.m. on the rebalance day

• Whatever the CMP of stock is available at 2:30 p.m. I place limit orders to execute my sell orders

• Once the majority of my selling is done, I start placing limit orders for my new buys

• If a stock I wanted to buy is in an upper circuit, then I move on to the next stock in the ranks

• I use limit orders for selling and buying, never a market order. I modify limit orders from time to time to get a fill as long as the stock is not in the circuit

Frequently Answered Questions:

There are a few questions that people ask me frequently. Here are answers to the same:

1. Do you check any fundamentals of the stock?

   1. No, I don’t use any fundamentals to select stocks. Many stocks come into my portfolio whose names I have never heard. I simply buy and sell according to what the system tells me

2. Does adding any other parameter improve the results of the momentum portfolio?

   1. You can add a few other parameters to the strategy. What I have observed is that the more the filters you add, the more returns go down

3. What lookback is best? 12-month, 6-month, or 3-month?

   1. Anything between 15 months to 3 months works fine. Over the long term, returns converge to similar cagr for any of these lookback periods. My answer is that choose whatever you feel comfortable with and can stick to in the longer term

4. How do you calculate Sharpe return?

   1. For the 12-month Sharpe return, I divide the last 12-month absolute return by the last 12-month volatility

   2. For the 6-month Sharpe return, I divide the last 6-month absolute return by the last 6-month annualized volatility

   3. For the 3-month Sharpe return, I divide the last 3-month absolute return by the last 3-month annualized volatility

5. How many stocks should I have in my momentum portfolio?

   1. Anything above 20 and below 50 is good enough. Returns start going down at 50 stocks if your universe is all listed stocks.

   2. Volatility and Drawdown increases if you have less than 20 stocks.

   3. Your exposure to single stock also increases a lot below 20 stocks

6. Do you adjust for dividends?

   1. No, I only adjust for splits and bonus. I don’t adjust for dividends

7. What index should I use for my universe?

   1. What I would say is that the lower you go in the marketcap, the probability of higher returns increases. But with a lower marketcap, the volatility of the portfolio also increases a lot

   2. Further, this is a stock market, so nothing is written in stone. We can only talk in probabilities. There is no guarantee that just because you are in microcaps or small-caps, you will get higher returns. Do what feels more comfortable to you and can stick to in the longer term

8. How much drawdown can I expect in a momentum portfolio?

   1. In any given year you can expect 25-30% drawdown

   2. In a turmoil situation like 2008 or 2020, you can expect 50-70% of drawdown as well

9. Which books to read to understand it further?

   1. You can read Quantitative Momentum by Wes Grey

   2. You can also read Stocks on the Move by Clenow

10. Anything further to add?

    1. I just want to say that momentum is not a holy grail strategy. The last few years have been really great for the momentum portfolios because of the underlying bull market.

    2. Momentum goes through huge drawdowns. Recently during 2018-19 phase, momentum portfolios crashed like anything and didn’t recover until the 2020 bull market for three years

    3. During the 2008 crash, most of the momentum portfolios didn’t recover until 2014

    4. Please make sure that your asset allocation is in place. Please don’t put all your net worth in momentum. It can go sideways for a lot of time

11. Where can we contact you?

    1. You can email me at viraj@virajkhatavkar.com

    2. You can connect with me on Twitter at @virajkhatavkar