Momentum trading is one of the most well-documented edges in financial markets. Academic research going back hundreds of years confirms it exists. The question is not whether momentum works – it is how to build a systematic approach around it that captures the edge without burning it through excessive turnover or poor stock selection.
Alan Clement is a certified financial technician, full-time independent trader, and private investment consultant based in Melbourne. He specialises in quantitative trading strategies and has built his practice around momentum and trend-following approaches to equity markets. In this BST live session, he broke down his framework in detail – from how momentum forms to the specific indicators he trusts, how to rank stocks, and how to use an absolute momentum filter to protect capital in downturns.
Watch the full episode below, then read on for the complete breakdown.
Why Momentum Exists – The Behavioral Foundation
Alan’s explanation for why momentum exists is grounded in market psychology rather than technical theory. Momentum is a market inefficiency driven by two competing fears: fear of loss and fear of missing out.
“As price starts to move up, people don’t want to miss out on the trend. They’re willing to pay a little bit more than the previous person. The trend develops. The stronger these trends are – the longer they’ve been in place and the faster moving – the more likely they are to persist in the short term.”
The analogy Alan uses is a skateboard rolling down a road. It keeps moving in the same direction until friction slows it down or it hits something. Markets work the same way. Trends develop, persist for a period, then eventually run out of steam. The goal is to identify them early enough to profit from the extension, and exit before or shortly after they reverse.
Importantly, the slow build of trends is what creates the opportunity. If price reflected all information instantly, there would be no edge. The fact that market participants are slow to reprice assets – and even slower to act on the repricing – is what leaves money on the table for momentum traders.
What to Look for in a Good Momentum Indicator
Alan’s criteria for a momentum indicator are specific. It needs to measure the strength and direction of price. It needs to remain elevated as the trend continues. It should be normalised across stocks of different prices. And it should produce a smooth, stable signal rather than a noisy one.
The indicators he returns to most often:
- Rate of change (percentage change in price) – the purest momentum measure, but noisy. Applying an EMA on top gives smooth rate of change, which is more usable in practice.
- ADX – has smoothing built in, but measures momentum in absolute terms. The DI+ and DI- directional components are needed to filter out downtrends when only taking longs.
- MACD – already uses two EMAs, so it is smooth by construction. At longer lookback periods it tracks trend momentum rather than acting as an oscillator.
- RSI – noisy at standard settings, but at longer lookback periods it also follows price up and down. Adding smoothing on top makes it more usable for momentum ranking.
Moving averages are not on this list because they show average price, not momentum strength. The value of a moving average is price-dependent and cannot be compared across stocks at different price levels.
The Lag-Reactivity Tradeoff
Every smoothing operation adds lag. This is the fundamental tradeoff in momentum indicator design, and Alan is direct about it: there is no way to eliminate it. The question is where you want to sit between maximum reactivity (noisy, lots of false signals) and maximum stability (slow to react, late entries and exits).
“Between those two extremes there’s a sweet spot in the middle. You usually have to run experiments to find where that sweet spot is in terms of the parameter setting.”
For Alan’s preferred timeframe – weekly bars with roughly a six-month lookback – this sweet spot tends to be in the range of moderate smoothing. Going too short (less than four months) produces excessive turnover and false positives. Going too long (over a year) produces late entries and exits that erode the edge.
Ranking Stocks for Relative Momentum
Once you have a momentum indicator, the next step is using it to rank a universe of stocks. Relative momentum compares how each stock is performing against the others in your universe. You buy the top decile or quartile – the stocks with the strongest momentum – and either hold nothing else or hold cash equivalents for the remainder.
Alan favours ranking on a normalised indicator so that a $5 stock and a $500 stock can be compared on equal footing. The percentage-based approach handles this automatically. Dollar-based measures do not.
Portfolio rebalancing happens on a regular schedule – typically weekly for short-to-medium timeframes. Each rebalance replaces stocks that have dropped out of the top tier with the new leaders, and exits positions that have lost their momentum ranking.
Absolute Momentum – The Market Regime Filter
Relative momentum alone does not protect you in bear markets. If the market is falling and you own the top-ranked stocks, you are still long and still losing money – just less than the index. This is where absolute momentum comes in.
Absolute momentum asks whether a stock is above its own historical momentum threshold – not just whether it ranks highly relative to other stocks. As the market falls, stocks will start to breach their absolute floor one by one, gradually reducing the number of positions in the portfolio.
“As soon as that list starts reducing, you start exiting those positions. The equity line goes flat. You’re not having to follow the market all the way down.”
Alan demonstrated this with a NASDAQ 100 example: the strategy held up to 12 positions at the peak, but as the market corrected, the portfolio progressively moved to cash. The equity curve flattened during the drawdown rather than following the market down.
Volatility in Position Sizing – What the Research Shows
A question came up in the session about whether to reduce position size on high-volatility stocks. Alan’s answer, backed by his research: generally, no.
“Your best returns tend to come from the more volatile stocks. If you think about a $5 stock, it can easily go to $10. It’s a lot harder for a $50 stock to go to $100. When you try to punish volatility in your position sizing, you’re basically cutting off that return stream.”
The caveat: if your goal is smoother returns rather than maximum absolute performance, volatility-adjusted sizing makes sense. But the cost is lower compounded returns over time. For a momentum strategy where the big winners matter disproportionately, cutting them out via position size reduction is counterproductive.
Why Momentum Works Better on Weekly Timeframes
Alan’s preference for weekly bars is deliberate. Daily bars introduce more noise, more rebalancing events, and more transaction costs. The momentum edge is more robust on longer lookback periods because you are capturing structural trends, not short-term fluctuations.
At shorter timeframes, the edge does not disappear but it becomes harder to extract. Turnover increases, false signals multiply, and the net effect on performance after costs is typically worse than a longer-term approach with fewer trades. For most individual systematic traders, weekly rebalancing hits the sweet spot between capturing the edge and managing execution costs.
Related episodes
- Entries, Exits and Trend Following with Larry Tentarelli
- How to Improve Trend Following Performance with David Lundgren
- Trading Market Phases with Mish Schneider
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