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Avoiding Momentum Crashes: Dynamic Momentum and Contrarian Trading

Last Updated on 10 February, 2024 by Rejaul Karim

Embarking on a journey through the intricacies of market dynamics, Victoria Dobrynskaya unveils insights into the enigmatic world of momentum trading in her paper, “Avoiding Momentum Crashes: Dynamic Momentum and Contrarian Trading.”

Spanning 33 pages, this work dissects the puzzle of high momentum returns, marked by an intriguing lack of explanation through conventional risk factors. Dobrynskaya delves into the negative skewness and occasional, profound crashes that punctuate the momentum landscape. Skillfully navigating this terrain, she introduces a dynamic trading strategy that metamorphoses in response to market tremors.

Seamlessly transitioning between standard momentum and contrarian strategies, the dynamic approach ingeniously transforms major momentum crashes into gains. Exhibiting resilience across diverse markets and temporal landscapes, this strategy not only mitigates downside risks but amplifies returns, embodying a nuanced dance between momentum and contrarian forces.

Abstract Of Paper

High momentum returns cannot be explained by risk factors, but they are negatively skewed and subject to occasional severe crashes. I explore the timing of momentum crashes and show that momentum strategies tend to crash in 1-3 months after the local stock market plunge. Next, I propose a simple dynamic trading strategy which coincides with the standard momentum strategy in calm times, but switches to the opposite contrarian strategy in one month after a market crash and keeps the contrarian position for three months, after which it reverts back to the momentum position. The dynamic momentum strategy turns all major momentum crashes into gains and yields average return, which is about 1.5 times as high as the standard momentum return. The dynamic momentum returns are positively skewed and not exposed to risk factors, have high Sharpe ratio and alpha, persist in different time periods and geographical markets around the Globe.

Original paper – Download PDF

Here you can download the PDF and original paper of Avoiding Momentum Crashes: Dynamic Momentum and Contrarian Trading.

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Author

Victoria Dobrynskaya
School of Finance, HSE University

Conclusion

In conclusion, the challenge of momentum crashes, characterized by negative skewness and occasional severe downturns, necessitates a strategic approach. This study unveils a dynamic trading strategy designed to navigate the intricacies of momentum investing.

By aligning with conventional momentum strategies during calm market periods and seamlessly transitioning to a contrarian stance in the aftermath of local stock market plunges, the proposed strategy effectively mitigates the impact of momentum crashes.

Notably, this dynamic approach not only safeguards against downturns but also transforms major momentum crashes into gains. With a robust performance across various time periods and global markets, the dynamic momentum strategy presents a compelling alternative, boasting superior risk-adjusted returns and resilience in the face of unpredictable market dynamics.

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FAQ

Q1: What does the paper “Avoiding Momentum Crashes: Dynamic Momentum and Contrarian Trading” reveal about the challenges associated with momentum trading?

The paper highlights that while high momentum returns cannot be explained by conventional risk factors, they exhibit negative skewness and occasional severe crashes. The study explores the timing of these momentum crashes and introduces a dynamic trading strategy as a response to the challenges posed by the negative aspects of momentum trading.

Q2: How does the proposed dynamic trading strategy work, and what sets it apart from conventional momentum strategies?

The dynamic trading strategy aligns with standard momentum strategies during calm market periods. However, it strategically switches to a contrarian strategy in the aftermath of local stock market plunges, maintaining the contrarian position for three months before reverting back to the momentum position. This approach transforms major momentum crashes into gains and outperforms standard momentum strategies, yielding higher returns with positive skewness and resilience across different time periods and global markets.

Q3: What are the key benefits and characteristics of the dynamic momentum strategy presented in the study?

The dynamic momentum strategy not only safeguards against the negative impact of momentum crashes but also turns these downturns into gains. It exhibits robust performance with superior risk-adjusted returns, high Sharpe ratio, and alpha. Importantly, the strategy persists across various time periods and geographical markets globally, making it a compelling alternative that effectively navigates the challenges posed by unpredictable market dynamics.

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