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Revisiting the Momentum Master Strategy
Last week, InvestorPlace.com CEO Brian Hunt asked me a simple question:
Does momentum trading work?
My answer to him… “Yes it does.”
Consider Bitcoin (CCC:BTC-USD), the granddaddy of all momentum trades. Using a simple 50-day simple moving average (SMA-50) to time buying and selling would have earned us splendid rewards.
Since 2018, that strategy would have turned $10,000 of Bitcoin into $54,300, outperforming the buy-and-hold result of $33,700.
It isn’t rocket science. In fact, SMA-50 is so rudimentary that you’re probably wondering “why would it even work?”
But it does. And I’ll explain why later.
Before that, let’s make sure I’m not just cherry-picking results.
Here’s the same chart for XRP (CCC:XRP-USD), the second-largest cryptocurrency in 2018 (The chart below is truncated to 2020 through 2022 for detail). Momentum trading would have earned a +48% return, versus a -50% loss.
And the strategy even works for coins that flopped. Here’s what happened with Bitcoin Cash (CCC:BCH-USD), the No. 4 cryptocurrency in 2018. Momentum-minded investors would have netted 19% in returns, despite the fact that the coin ultimately lost 82% of its value.
In fact, SMA-50 has worked for every top 10 cryptocurrency since altcoins became relevant during the boom of 2017 to 2018.
But Technical Analysis Shouldn’t Work!
By now, you’re probably skeptical as hell.
Why would some former Wall Streeter be giving away a money-making strategy? And anyway, how can SMA-50 work when it’s up against high-frequency hedge funds with their machine-learning algorithms?
1. The Strategy Needs Some Thought
If investing is a game of chess, then the Momentum Master strategy is much like the Queen’s Gambit — one of the oldest openings still used by amateurs and grandmasters alike (for non-chess players, it’s a powerful move that provides a center-board advantage).
But much like any chess opening, Momentum Master can fail if used against the wrong opponents. Try using a momentum seeking strategy on value stocks or commodities, and you’ll quickly find that their mean-reverting nature becomes death by a thousand cuts. Use a momentum reverting strategy on growth stocks, crypto or meme stocks, and you’ll miss every breakout.
That’s why I call it the Momentum Master strategy. You’re not buying momentum or selling momentum.
It’s about becoming a master at applying the right strategy.
2. Variations Make the Strategy More Powerful
A 2019 study by researchers at Dublin University found data-driven evidence that SMA strategies work on cryptocurrencies, and that the effect is enhanced by using variable-length MA:
“We find that the variable-length MA is the most beneficial trading strategy to be applied when trading Bitcoin… supporting the conclusion that this technical rule present evidence of predictive power in cryptocurrency markets”
Applying these rules to cryptos like Dogecoin (CCC:DOGE-USD) shows similarly strong results. A 25/50 crossover MA would have generated a 690% return on the currency with fewer than half the trades of an SMA-50 strategy. Any investor would have outperformed 1.2:1 on a per-trade basis.
3. The Market’s Big Enough for Both of Us
Next, why would anyone share their “secret” trading strategy?
That’s because, like many other professional investors, I’ve learned that the market is vast. It’s so big that no matter how much I can eat, I’ll never be able to make a dent in the buffet table.
But if that’s not enough, here’s another reason: investing is not a zero-sum game.
When I bought shares of Amazon (NASDAQ:AMZN) in 2014 after it dipped to $280, I wasn’t competing against other buyers; anyone who bought in would have also seen a 160% gain by the end of 2016. Instead, we were buying from sellers who had already seen massive returns. And even those sellers could have gone on and bought Netflix (NASDAQ:NFLX)… Apple (NASDAQ:AAPL)… Microsoft (NASDAQ:MSFT)… you get the idea.
4. Some Patience Required
Finally, the Momentum Master strategy works because it takes time. Unlike hedge funds strategies that need to post quarterly (or sometimes daily!) returns, momentum strategies are better suited for individuals who can sacrifice short-term returns to land long-term 10x winners.
Let’s revisit Bitcoin’s performance.
An investor who used the strategy would have seen major drawdowns at first as the crypto market stagnated. By the end of 2018, you would have been -30% in the hole — enough to get any hedge fund manager fired.
But if you held on, those losses would have reversed by early 2019 and rocketed up 455% today.
The strategy is also filled with false flags. Since 2018, the SMA-50 strategy would have triggered only eight profitable transactions out of 35 total. The remaining buys were quickly followed by 1-4% loss-cutting sales.
Even promising buys need stop-loss protections. Last week, I recommended purchasing Immutable X (CCC:IMX-USD) after it broke through its 50-day average of $4. The cryptocurrency fell below that figure the following day, triggering an immediate “sell” signal.
But if you’re trading your personal account, none of that matters. Much like hitting a hole in one or beating a chess grandmaster, style points don’t mean much when you’re only answering to yourself.
The Four Cryptos Triggering Momentum Master
On Monday, Momentum Master suddenly turned bullish on cryptocurrencies when Bitcoin burst through $42,900. It’s since advanced another 5%, illustrating the obvious point that momentum-seeking assets need momentum-seeking strategies.
With cryptocurrencies in a rebound, here are some more recent additions to the Momentum Master “Buy” list:
- Dogecoin’s anemic rise to 16 cents now places it in “buy” territory, despite a seeming lack of meme-driven madness.
- Shiba Inu (CCC:SHIB-USD) triggered a “buy” rating after crossing 28 micro-cents on Monday.
- Solana (CCC:SOL-USD). The “Ethereum Killer” is approaching its $141 price target. Investors should keep careful watch.
Finally, Ethereum (CCC:ETH-USD) is now on track to hit its $3,265 SMA-50. If it reaches that point, investors should take it as a strong “buy” signal.
Bear Market Fears Loom
Of course, today’s crypto recovery could become tomorrow’s bull trap. Bitcoin remains 40% off its peak, and markets still seem ill-prepared for another financial shock. The VIX volatility index remains 50% higher than its long-term average, despite rosy economic outlooks.
Fortunately, the Momentum Master strategy also tells us when to cut losses, making it my No. 1 strategy for managing bear markets:
- Bitcoin (BTC). Sell below $41,600.
- Ethereum (ETH). Sell below $3,170.
- XRP (XRP). Sell below $0.73.
- Cardano (ADA). Sell below $1.20.
- Solana (SOL). Sell below $137.
These figures give a 3% allowance for intra-day volatility.
The Magic Formula that Still Beats Wall Street
In 2005, hedge fund manager Joel Greenblatt outlined his “Magic Formula of Investing” in The Little Book that Beats the Market.
The formula was straightforward. By ranking companies by 1) earnings yield and 2) return on capital and then choosing the top 20 to 30 firms, an investor would have returned 30.8% per year. $10,000 would take just 17.5 years to turn into $1 million.
But just like Momentum Master, Mr. Greenblatt’s formula raised eyebrows. How could a simple rule beat thousands of smart, overpaid Wall Street traders?
The successful manager revealed his thoughts in an afterword to the 2010 edition. He noted that the Magic Formula can underperform for years at a time. And for institutional investors, it’s impossible to sit on the sidelines while star fund managers like Cathie Wood are earning billions.
That’s where patient ordinary investors have an advantage: They don’t have to worry about winning points for style. By picking your battles, and only investing when the time seems right, you too can apply these winning strategies to beat the market.
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On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.