Momentum Trading Strategies Part VII: Hot Hands ETFs 2011 Summary

by: Fredrik Arnold

This article is the seventh in a series summarizing and updating an ETF momentum trading strategy called "Hot Hands" by Courtney Smith. Courtney is a trader, author, money manager, educator, and trading advocate.

Hot Hands aims to select and invest in the strongest performing ETFs and is traded monthly. Momentum traders seek to enter the market at the start of large market moves to the upside (or downside). The Hot Hands trading method is accomplished in three steps.

Hot Hands in Three Steps

Step One

Select ETFs for purchase by going here. In the "Performance" sector (found in the upper left of the front page of ETF Screen main page) you will find a list of ETFs.

Use filters atop the ETF Performance list to include short funds and, if you so choose, leveraged funds. Leveraged funds are optional to multiply potential rewards and risks in a fund by two or three times. Use the volume filter to choose funds trading in volumes over one million or over five hundred thousand shares. Be sure to click to update the page after you adjust the filters.

Click the downward pointing arrow on the column labeled Rtn-1mo at the top of the Performance list of ETFs and ETNs. This action will find the strongest performing exchange traded funds ranked from high to low by last month's returns. After generating the list, cull VIX funds, unintelligible titles, and funds with similar assets to create a well-diversified list.

The VIX Index is a measure of expected market volatility and since it is a range trading index and does not trend, it is not appropriate for momentum trading. If you don't understand the title of the fund, discard it, and also funds with underlying assets identical or similar to a fund already chosen, gold or silver, for example.
The lists and summary below are charts of 10 ETFs from, ranked high to low, sorted by one month returns as of 6/28/11; 8/12/11; 9/2/11; 9/30/11; 11/1/11; 12/1/11.

Click to enlarge.

Step Two

Determine how much to invest and how many selected ETFs to buy. Using a conservative $5,000 or $10,000 invested in the ten funds selected in the previous article as of December 1, the example below reports results from buying an even number of shares costing closest to $500 or $1000 for each of the ten selected exchange traded funds. The broker is acknowledged with a commission of $10 per trade deducted from every transaction to reveal net income in the scenarios below. Courtney recommends investing no more than 1% of your total investment portfolio in any one Hot Hand ETF or ETN.

Step Three

Wait one month before selling the selected funds in favor of a newly selected incoming group of stronger performing funds as ranked by monthly returns reported on the ETF Screen website. In less volatile markets, the funds can linger in the top ten for several months. There are no examples of such lingering funds in the December charts below. Set buy stops at $.10 above 55 day historic high for each fund selected and set sell stops at $.10 below 20 day historic lows for each. Or trade based on trend analysis, setting stops based on recent swing highs and swing lows in price using the same $.10 high/low margin for trade stops.

Comparison of Results Using Market Orders vs. Trend Analysis in 2011.

The Market Order Method places open trades with no stops as of the beginning of one month and reviews those trades at the beginning of the next month to sell off or continue. This method implicitly trusts the idea that the etf screen selections will continue their trajectory from the previous month into the next month. In 2011 this method worked best in July, somewhat in August and totally fell apart the rest of the year. The market order method bested trend analysis twice in 2011 in July and November.

Trend Analysis sets stops for buys and sells based on 55 day historic high for each fund selected or 20 day historic lows for each. Stops can also be based on recent swing highs and swing lows in price. In each case the stops are set at $.10 above recent highs for buys and at $.10 below recent lows for sells.

2011 Hot Hands ETF Results by Month

Click charts below to enlarge:

Conclusion: The Hot Hands ETF Annual Summary

Both methods, market order, and trend analysis lost money in 2011 as the markets couldn't decide to be bearish or bullish during one month after another from August through November. However, the market order method lost almost twice as much money as the trend analysis strategy. This result only underscores Yale professor Robert Shiller's admonition to "make conservative preparations for possible bad outcomes."

Click to enlarge.

Disclosure: I am long GLD, SEF. This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security. Prices and returns on equities in this article are listed without consideration of fees, commissions, taxes, penalties, or interest payable due to purchasing, holding or selling same.