Constructing anchored momentum from a centered average

Ordinary momentum

Ordinary momentum is the latest price minus an older price over a chosen momentum period. The percentage form is 100 times that difference divided by the older price.

A complete momentum strategy, as used here, is an entry, exit and abstention procedure whose signal is a percentage-change momentum reading over a stated holding period. Percentage momentum with a common period is the form used to compare and rank different securities fairly.

A centered simple moving average

A simple moving average is centered by shifting it left by half its period so the plot is smoother than price, is not delayed relative to price, and ends short of the last bar.

That centered simple moving average is an ordered-price smoother used here as a centered simple-average reference. It can also be used later as an exponential smoother of the latest price.

Pin the lookback to the centered average

Anchored momentum starts at the end of a centered simple moving average and ends at the latest close, so the left end rides a smoother reference than a single older price. The reading is measured from the latest price back to a point on the centered average rather than to a single older close.

A mid-1996 comparison

On a mid-1996 NASDAQ composite example, a 10-day anchored reading was smoother than a 10-day ordinary reading and was not delayed relative to it.

In that same example, July price dips later inflated ordinary-momentum peaks in August, while the anchored reading stayed closer to contemporaneous index action.

The same reading as a rank rule

When securities are ranked by percentage anchored momentum rather than percentage ordinary momentum, ranks change more gently and a mutual-fund ranking system is less likely to chatter through buy or sell triggers after past price bumps.

Rank rotation, in this use, ranks securities by the same-period percentage momentum reading and trades only when rank crosses a trigger.

One variable or two

General anchored momentum has two variables, the momentum period and the centered-average period. Most anchored momentum uses the longest allowed centered average and leaves only the momentum period free.

The one-variable form is easier to calculate and, in a trading system, leaves less room to overfit. The two-variable form keeps a controllable amount of past-bump influence when that influence is judged useful.

Smoothing the latest price

Smoothing the latest price with a moving average removes remaining jaggedness at the cost of a little delay. Either form can take an exponential average of the latest price as an extra variable.

TradersWeek editorial

TradersWeek editorial: pinning the lookback to the centered average keeps one percentage reading that can be tested as a momentum strategy over a stated holding period, then reused as a rank-rotation rule that fires only when rank crosses a trigger. Choosing most anchored momentum leaves the momentum period as the main free choice.