Dual Momentum: Why “Buying Winners” is Safer Than Diversification
Dual Momentum: Why “Buying Winners” is Safer Than Diversification
EXECUTIVE SUMMARY
- The Mechanism: Dual Momentum combines two forces. 1) Relative Momentum: Buy whatever is performing best (e.g., US Stocks vs. Int’l Stocks). 2) Absolute Momentum: If the asset’s return is negative (below cash), switch entirely to Bonds.
- The Logic: Standard diversification holds losers hoping they will recover. Momentum sells losers to buy winners. It is a dynamic allocation strategy that adapts to market regimes.
- The Payoff: Historically, this strategy (“GEM”) has delivered equity-like returns with bond-like volatility, avoiding massive drawdowns like 2008 or 2000.
- Authority Baseline: This analysis utilizes the academic findings of Jegadeesh & Titman (Momentum Anomaly) and the practical application by Gary Antonacci (GEM Model).
“Buy Low, Sell High” sounds nice, but “Buy High, Sell Higher” is mathematically superior. Newton’s First Law applies to finance: An object in motion tends to stay in motion. Dual Momentum is the discipline of riding the wave until it breaks, then getting out of the water before the tsunami hits. According to Team BMT Analysis, this is the most robust “Trend Following” strategy available to retail investors using simple ETFs. Source: Optimal Momentum (Antonacci) / Portfolio Visualizer
Scenario: You check your portfolio once a month (e.g., last day of the month).
- Step 1 (Check Trend): Is the S&P 500 (SPY) return over the last 12 months higher than T-Bills (Cash)?
No: Sell everything. Buy Aggregate Bonds (AGG). (Safety Mode).
Yes: Proceed to Step 2. (Risk-On Mode). - Step 2 (Pick Winner): Is the S&P 500 (SPY) higher than International Stocks (VEU) over the last 12 months?
Yes: Put 100% in SPY.
No: Put 100% in VEU. - Result: You are always in the strongest asset, or safely in bonds. You never hold the loser.
BMT Verdict: Diversification is a hedge against ignorance. If you don’t know what will go up, you buy everything. Momentum is a hedge against stubbornness. It forces you to admit what is actually working and align your capital with the market’s verdict, not your opinion.
Performance vs. Drawdown (1974-2023)
| Strategy | Annual Return (CAGR) | Max Drawdown (Crash Depth) |
|---|---|---|
| S&P 500 (Buy & Hold) | 10.5 | -51 |
| Global Equities Momentum (GEM) | 15.2 | -17 |
*Chart Note: The magic isn’t just the higher return; it’s the Drawdown reduction. By exiting to bonds in 2000 and 2008, the strategy preserved capital to compound faster when the bull market returned.
“But isn’t this market timing?” Yes, it is systematic market timing. And the data proves it works because human nature does not change. Investors under-react to news (creating trends) and then over-react (creating bubbles). Momentum exploits this behavioral flaw. It is not guessing; it is measuring.
CRITICAL SCENARIO: The “Whipsaw” Cost
The price of insurance.
| Market Condition | Momentum Outcome |
|---|---|
| Strong Trend (2013, 2017) | Huge Win. You stay fully invested in the leader. |
| Sideways / Choppy (2011, 2015) | Small Losses. The system buys the top and sells the bottom repeatedly (Whipsaw). You might underperform Buy & Hold by 5-10% in these years. This is the “premium” you pay for avoiding the -50% crash. |
Execution Protocol
Keep it simple.
US Stocks: IVV or VOO.
Int’l Stocks: VEU or VXUS.
Safe Asset: BND or SHV (Short Treasuries).
The classic academic standard is 12 Months (specifically, return over the last 12 months, excluding the most recent month, or simply 12-month total return). Don’t use 1-month returns; it’s too noisy.
Log in on the last trading day of the month. Check the returns. If a switch is needed, sell 100% of the old asset and buy 100% of the new one.
Tax Note: Do this in an IRA or 401(k). Frequent switching in a taxable account generates short-term capital gains tax, which destroys the alpha.
This strategy requires monthly attention and the psychological strength to be “out of the market” when everyone else is bullish (if the trend breaks). If you want “Set and Forget,” stick to Indexing.
WEALTH STRATEGY DIRECTIVE
- Do This: Use Dual Momentum for your “Risk Capital” in a tax-advantaged account (IRA). It serves as a dynamic risk management tool that complements a static Buy & Hold portfolio.
- Avoid This: Using complex “Sector Rotation” momentum (e.g., switching between Tech/Energy/Utilities). The transaction costs and tax drag are too high. Stick to broad indices (US vs. World).
Frequently Asked Questions
Is there an ETF for this?
Yes. QMOM (Alpha Architect) and MTUM (iShares) use momentum, but they stay invested in stocks 100% of the time (Relative only). True Dual Momentum (switching to bonds) is rare in ETFs due to regulatory constraints. You often have to do it yourself.
What if stocks and bonds both fall?
This happened in 2022. Dual Momentum switched to Bonds, then Bonds fell. The strategy suffered. The modern fix is to use Short-Term Treasuries (SHV) or Managed Futures as the “Safety Asset” instead of Aggregate Bonds.
Does it work with Crypto?
Extremely well. Crypto is a pure momentum asset class driven by sentiment. Applying a simple trend rule (e.g., “Buy if Bitcoin > 200 Day Moving Average”) has historically avoided 80% drawdowns.