[MUSIC]. Learning outcomes. After watching this video, you will be able to implement the momentum strategy. [MUSIC] >> So I've told you about the possible losses that can happen on momentum strategy. So let me give you some kind of a list as to how much one may lose if one is stuck at the wrong time in any moment of strategy. So in this paper Moscow is in the kind of nil. They do this, they work out this numbers. So if you see the table 2 in the paper. The shorter term in 1932, immediately after. Of the Great Depression when the recovery happened. During that time, August of 1932, everyone had followed a plain momentum strategy of buy the winner and sell the loser. In one month, in that month of August investors would have lost, 74%. Well that's huge. You lose three of your portfolio. Well that's crazy. And after that the rank. In 1932 July, again a 60% loss. So 60% loss in July followed by 75% loss in August of 1932. So you can imagine. So if you apply the four filters, this is the time when it fits quite well. As I've told it's hard to say that their upward movement is a rebound or not. But then other three conditions like has there been a panic, was the wallet already high, has there been a crash? This time would have satisfied. So somebody was not aware of a momentum crash. A regular momentum trader would not have thought about this crash and would have entered into this strategy, executed this strategy, held on. Such a person would have lost 60% in July 1932, followed by 74% in August 1932. That means entire portfolio's wiped out, that's all. So again, 2001 again 2001 January when the market recovered after the dot com bubble, the negative return is like to the extent of 50% 49%. 2009 April, March was the bottom followed by recovery, this is very recent so look at the beauty of this, this has been there for almost forever. From 1930 to 2009 that has been the characteristic of the market. If you follow a momentum [COUGH], sorry, momentum strategy during this recovery phase you are likely to lose a lot. So 2009 April the loss was like 45%, again in 1939 September 43%. 2009 March a negative 42% so on and so forth. So these are all again recent 2001. October 24% 1974. They recovery after the oil 25%. So, the point is this, losses can be big. So while momentum works on an average as we have seen in that momentum paper and the numbers that was shown by. This moment strategy works really well on an average but these losses can be big. Now we have set all these up and one more thing. To add insult to injury, if you see the market written during those times. Let me give you that example. Let's take 1932. Momentum return [COUGH] is- 74 the portfolio of by the winner seller loser entered- 74. But the market was + 36. See all this time when the momentum, let's take 2009. When the momentum strategy gave- 45, market return was +10%. So, this is a time in the market that is actually going up. I have told you about this before. So, when the market goes up, this portfolio is losing, so if you are investing somebody else's money, the investor will be mad at you. So this is the wrong time to lose money. And the market is going down if you lose money and people will still understand. You will be losing money when the market goes up. So that's why it's very important to know how to protect oneself from this kind of a loss. Now you're given so much background but the strategy to follow in this kind of a situation is fairly simple. I can explain this in one line, that's all. Instead of going short on losers, just buy put options. That's all. So plain momentum then what do you do? [COUGH] You go long on the winner and short the loser. Here, go long on the winner, buy put option. Now let's see what is the logic? Why am I saying put option, why not call options for going long? The reason is simple. Please note, if you read the abstract carefully, if you've heard the abstract carefully. The loss happens because the stocks that have loss out during a crash. They acquire this option like feature, call option like feature and then rebound significantly. So the loss is actually happening in a phase when the market is recovering. So what is causing in your long short portfolio, what is causing loss is the recoiling of the stocks you have shorted. It is not, see a momentum trader can lose because of two reasons right? Because you are long on something, short on something. If your long falls more than your short then also you lose. And if your short goes up more than your long, then also you lose. This is the second situation that is happening. So the reason for the laws here is the sharp of stocks that were shorted. Now that is what you need to cover for. So the cover for that is put option. Remember why buy put options? When you expect a fall but you want to be protected from a sharp up move. That's exactly the purpose of production. So I have to spend a lot of time explaining options otherwise you wouldn't understand this part. That's why I spent a lot of time in explaining option now I'm surely hope you appreciate. So if you have this fear that my strategy will work on an average. But there is a possibility of a crash and I can't predict this crash. Now exposure, it's always nice to say in 1932 market recovered in August and you should not have done momentum. But [INAUDIBLE] sitting in 1932, before 1932 it would have been hard to predict this. Every recovery if you stop trading momentum, then you may never be able to trade momentum stocks. So that is why if you buy put option instead of going short then you're likely to be significantly into from this momentum crash. Now is this insurance going to be free? Not at all. No insurance in the world is free. This will cost you. This will cost you a premium. So only think that it will do is it will add this premium becomes a cost. And your return from the momentum strategy then needs to be higher. It needs to cover this premium, as well. Let me give an illustration. Let's assume that you went long. Your longs. And you have shorts. So let's assume you are now plane momentum, I'll call it pm and like we see momentum crash. Now, assume that you hold this strategy and you hold it for a month, now imagine that your long sale went up by 10%. So we are talking about, this is a momentum crash scenario, that means there has been a decline, there has been a panic. And the high volatility and the stocks are rebounding. And you're short about 80%. Now you know that this is not a implausible situation. This has happened. So then what happens? You are return. You gain this, you lose this. Because you're long sorry. You gain this and you lose this much I'm sorry. So ten gain, 80 lose. So this is actually negative for you. So I'll make it negative, the stock is up so you make, you loose 70%. This is your lose. If you are to follow plain momentum crash. Now imagine that you follow this momentum crash strategy. No, it is not a momentum crash strategy, it's a momentum strategy with some kind of op protection. The same situation. Now this you gone long will remain ten. What will happen to this? If you bought put options in the stock and the stocks go up 80% then what is going to be your payoff? Go back to your notes, go back to the other video where we spoke about payoff of put options and think carefully. What will happen now? [BLANK AUDIO] So I think, it's a nice time to pause and think about it. So, your payoff is going to be, zero. So, because the stock will go up and the option will expire worthless so this is going to be zero. However you will pay a premium. Imagine the cots of premium is 5%. So instead of losing 70%, you may end up gaining 5%. And this, even if this premium cost was 15%, this depends on the kind of market you are in. In a very efficient market, highly competitive premiums will be low. In a market which is not efficient, premium will be high, that one must be aware of. Even if it is 15%, your lose will be 5%. So imagine a situation where this is 20. Even in a 15% cost situation you will gain 5%. So even in an extreme loss scenario like this for momentum. If you use put options, please remember options protect you from extreme volatility. So if you use put options, you will gain then rather than lose. So instead of losing 70%, you will gain 5% in this scenario. So does this mean that all the time you should do it? You could depending on your risk appetite, but this is not free. As we've seen, there is a cost. Ideal situation where this can lower standards. Think about our happy situation for a momentum trader, which is likely to be the case, most of the time. Think of our situation, variable long, went up 20%. And short, went down 20%. Now it went down, say short remain unchanged, let us make that scenario, sorry. Zero. So if you bought plain momentum, you make 20%. I am just ignoring broker agent, other costs, you have to deduct from that, it is obvious. You make 20%. Now if your momentum crashes. So this 20% you make, but what will happen here? You're premium cost will bite you. If it is say, a liquid market, if the stock is liquid for let's say 15%, you're returns will go down. In plain momentum, you'll do 20. In this momentum crash strategy you'll do five. So there is a cost, in finance, there is absolutely no free lunch. In fact in a way the anomalies strategies that we're talking about, we are trying to figure out free lunch. But the point we are trying to make is, that is why you need to be aware of risks of these strategies. These are not strategies where you make money without taking any risk. That's not the case, there is risk. So this is the risk. So there is a cost involved. So suppose this crash does not happen, if this is the state of the world for five years in a row, which can happen. You will always under perform momentum Irrespective of which way the market is going. Same thing will happen let's say, this is a situation where at least put off options are not exercised. Imagine a case, where this was- 20%. If this was- 20% this can be a homework or quiz for you. You would have made 40% here. But here, what will happen? Now you gain -20 but 15% you lose, so your return will be just 25%. So whatever it is, on an average you'll make 15% less than the normal plain momentum trader. That's the cost. So the strategy's simple and straightforward. This buy put option instead of going short on stock that's wrong. But you should remember that it comes with a cost. The cost is cost of premium. So the question you need to ask yourself is how much protected I am? Do I think that these possibilities exist? And if you think that those four conditions exist then it is better to go for a momentum crash strategy. The fourth condition is very hard to verify trust me, it's can only be known after the fact. You can, top or a bottom is usually called much long after that actually happened. We know in a top or a bottom it's hard to say whether it's a top or a bottom. So that is difficult, but the other three one can think about it. As I've told you before, think about the current situation. We are not in that situation, so it is better to go for plain momentum strategy. We are not in a panic kind of a situation right now. So otherwise whenever there has been a crash you never know when the market is going to recover, this is likely to do better. This can save an investor because this kind of a negative return can wipe out an entire portfolio. So that is where this momentum strategy is useful. So that's all about the strategy. Any questions any doubts you guys have you can write to us. Thank you.
