[MUSIC] Learning outcomes. After watching this video, you'll be able to discuss the returns generated by momentum strategy in the Indian Market. Know the latest developments in the momentum strategy. Now, we now apply the momentum strategy to the Indian market. As mentioned previously, we use a look back period of 12 months. And holding periods waiting from one quarter to four quarters. We create the portfolios at the end of month of the look back period. To calculate the normalized return, we will use a risk free rate of 6.75%, and an inflation rate of 3.63%. The results we got are as follows. For a look back period of twelve months and three months holding period, we get an average effective annual return of 16.92%. And a normalized return of 6.54% for a look back period of 12 months. And six months holding period. An average effective annual return of 15.19% was obtained, with the normalized return being 4.81%. For a look back period of twelve months and nine month holding period, we get an average effective annual return of 15.72% and a normalized return of 5.34%. Finally, for a look back period of 12 months and a 12 month holding period, we get an average effective annual return of 16.54% and a normalized return of 6.16%. Now, these are relatively high returns. And all of them are greater than the risk free rate and have successfully beaten inflation and the market returns. Let us not stop here. Let us study the remaining 12 strategies also. The slide has the average effective annual return. Obtained with different combinations of look back periods and holding periods for the year 2016. From that table, it can be seen that the minimum return obtained is of 12.54% for a three month look back period and six month holding period. And a maximum of 20.60% for a look back period of six months and a holding period of three months. If you notice, the 12 month look back period does not give the highest returns. It is a six months look back period that gives the highest returns. Now for a holding period of three months, the six month look back period strategy gives a return of 20.60%. Compared to the 16.92% of the 12 month look back period strategy. Also, the six month look back period strategy outperforms the twelve month look back strategy for all the holding periods. You can see for yourself. 20.60% compared to 16.92%. 18.55% compared to 15.19%. 16.37% compared to 15.72%. 17.34% compared to 16.54%. This is what I was telling you initially. You should experiment with various strategy and pick the right one. Let me warn you here. Just don't follow the reasons that I'm showing you blindly. The returns given by these strategies can vary depending on your country. Also, they might change next year. Next year, the 12 month look back strategy might give you the highest returns. Who knows? And also one more thing I would like to mention here. If you look at the table, there is no trend whatsoever. This should again remind you that you cannot blindly trade on the results. All right, we have seen the returns the strategy has generated in the Indian market. But before you start trading, I would like to discuss a few things. The first thing I would like to discuss is how many stocks should be there in the portfolio? Normally, the winners and loser portfolio used by academicians usually have dozens of stocks. And the portfolio returns are calculated based on the returns of all of these stocks. Now it is very difficult for small retail investors like you and me to have such huge portfolios. So what is the size of the smallest portfolio of stocks that can still be used? Research has been done in this area and the reasearch shows that having a small portfolio is not a problem. You can capture the momentum effect even by having a portfolio of around 50 stocks. Now recollect, diversification is very important as you have seen in the previous videos. Just because you're following a particular strategy does not mean that you forget diversification. And diversification puts a lower limit on the number of stocks we can have in a portfolio. So 50 stocks is a good enough number to diversify your portfolio and that is the reason why we are suggesting this number 50. The second thing I want to discuss is some developments in the momentum research. People have defined two categories of momentum. First is the Time-Series momentum. This is also known as absolute momentum. As the name suggests, absolute momentum is calculated based on stock's historical returns, independently from the returns of other stocks. Now historical returns mean past returns. Second is the cross-sectional momentum. This is also known as relative strength momentum. Again, as the name suggests, this is a measure of stock's performance relative to other stocks. Now using these two definitions, let us decide or let us see how we can decide winners and losers. Let me take an example. You to have two stocks, Pepsi and Coke. The initial price of both the stocks is $10. Pepsi is $10, Coke is also $10. After 12 months, the price of Pepsi stock is $30, and the price of Coke stock is $20. The net return on Pepsi stock is, yes, 200%. And that old Coke stock is 100%. Now if you are using the time series momentum definition to pick winners and losers, then a stock having a positive performance over the past 12 months is called a winner. So in our case, Pepsi and Coke, both the stocks are winners. This means we long Pepsi and we long Coke. But in case you are using the cross-sectional momentum definition to pick winners and losers, we pick a stock whose past performance over the past 12 months is relatively stronger than the past performance of other stocks in the universe. Now what is our universe here? Pepsi and Coke. We have only two stocks in the universe. So if you look at the returns, Pepsi is the winner. So we long Pepsi and short Coke. Now, I know what you are thinking. You are thinking if there is any way in which you can combine both the strategies. Yes, you can also combine both strategies. In that case, we long Pepsi because both the definitions say buy Pepsi and we take no position in Coke because one says buy and the other definition says sell. The momentum strategy we have studied previously is based on cross-sectional momentum. If you recollect, we divided the stocks into designs based on their relative performance. Now this same strategy can also be extended to a time series momentum definition. But before we do that, let me tell you one more thing. We have also seen that there is a disadvantage with the cross-sectional momentum strategy. And that disadvantage is we have to use a universe of assets to pick past winners. Now we can overcome the situation using time series momentum. No, we don't need the entire universe of stocks to exploit the momentum effect. According to time series momentum, each stock's intermediate momentum is future predictor of returns. So, we have a slightly new version of the momentum anomaly. Which is let us call it the time series momentum anomaly. This anomaly shows that each security's own past return is a predictor of future returns. In simple words, what this means is the past 12 month excess return of each stock can be used to predict its future return. But wait, wait, let's hold on for a second. This does not mean that you will start trading single stocks. Please remember that diversification is still important. So even though you are using time series momentum, remember to have very diversified portfolio of stocks. Research has shown that a portfolio of very diversified stocks based on the time series momentum strategy is stable and robust. Now before we end, there is one last thing that might interest you. The time series momentum returns appear to be largest when the stock market's returns are most extreme. This means, this strategy can be used as a hedge for extreme events. With this, we have come to the end of the momentum strategy, and happy trading to all of you. [MUSIC]