Dual Momentum: Relative or Absolute Momentum First?

When Gary Antonacci first shared the Dual Momentum strategy, he outlined a specific process that DIY investors could follow to narrow their investment of choice using absolute momentum (time-series momentum) and relative momentum (cross-sectional momentum).

Both forms of momentum are demonstrated by ample academic research as generating better risk-adjusted returns compared to simply holding the underlying security in all market conditions.

Gary was the first person to publicly share the outsized returns an investor can achieve by combining the two forms of momentum using major asset classes. He called this investment strategy "Dual Momentum" and it has become very popular among self-directed investors.

Dual Momentum is noted for its simplicity. The strategy only uses three broad asset classes: U.S. Stocks, International Stocks, and Bonds. The investor uses a 12-month lookback period to find the recent returns of each asset class and then follows a simple process to get the "Dual Momentum signal" for the next month.

Gary Antonacci's Process

As you can see, the process is simple and covers both forms of momentum: absolute momentum and relative momentum. Gary tests for absolute momentum on U.S. stocks first in his process. This means an investor would neither be invested in U.S. nor International stocks if the U.S. equity market was underperforming Treasury bills.

While this model is simple to follow, my first thought as an investor based outside of the U.S. was: why test absolute momentum on U.S. stocks first? What if the rest of the world is performing well while U.S. stocks are experiencing a correction?

By testing absolute momentum on U.S. stocks first, we open ourselves up to single market risk. There is a real possibility of being invested in U.S. bonds while global stocks and global currencies were doing well. This would compound the downside from a global purchasing power standpoint.

In his book, Gary shares that U.S. stocks lead markets. Based on this thesis, an investor could test for absolute momentum on U.S. stocks first as a type of leading indicator on all equities. While this argument has certainly held true for most of the past century, I'm not so sure it will persist.

In the 1900s, we saw a major shift to a U.S.-based global economy. The U.S. economy dominated the world and global currencies were almost exclusively pegged against the dollar (via gold standard or trust in U.S. institutions). In fact, during the second World War this arrangement was formally adopted via Bretton Woods.

However, in recent decades other economies have increased their influence substantially. The People's Bank of China, the European Central Bank, and to a lesser extent the Bank of Japan carry a lot of weight. We are entering a period where the U.S. is slowly receding in relative economic dominance. This could hurt investors who rely solely on U.S. stocks to drive portfolio returns.

Considering the Dual Momentum model provides global diversification, I could understand a case for testing absolute momentum first if the test was applied to the global stock universe. We could evaluate the absolute momentum of the MSCI ACWI Index to determine if we should invest in stocks or bonds.

If the absolute momentum test determined global stocks were outperforming cash, we could run a relative momentum test to determine if we should invest in U.S. stocks or International stocks. In large part the relative momentum gains realized by the investor are driven by currency changes. U.S. stocks tend to outperform when the U.S. dollar is doing well against other global currencies; International stocks do well for U.S. investors when global currencies are outperforming the U.S. dollar.

That said, there is an easier way to do this without having to track another indicator. It would also keep the currency performance impacts separate.

My Dual Momentum Process

In my process, I test the relative momentum component first.

I begin by identifying which broad stock market class is performing better: U.S. stocks or International stocks. Once we've identified the stronger of the two major equity markets, we ensure we are investing in a rising asset by checking the absolute momentum of that market.

In this slight variation of the process, we can eliminate the risk of holding bonds while foreign stocks and currencies are doing well.

Relative Momentum First or Absolute Momentum First: U.S.A.

Sources: TheRichMoose.com, MSCI Inc., FRED

When comparing the two methods of Dual Momentum using U.S. stocks as the base, there is a slight historical performance advantage for testing absolute momentum first.

In this backtest, both methods are very comparable over the test period with the only substantial deviation occurring in the early-1970s. Even in this period, my suggested method quickly caught up to Gary's method by the end of the decade.

In the end, an investor testing for absolute momentum on U.S. stocks first (Gary's method) would have realized a +16.14 percent compound annual return during the test period.

The same investor testing for relative momentum of equities first (my method) would have realized a +15.93 percent compound annual return. This is effectively an indiscernible difference.

We can also look at a rolling period return to examine the differences in returns between the two methods more closely.

Sources: TheRichMoose.com, MSCI Inc., FRED

Testing absolute momentum first with U.S. stocks does show a general advantage earlier in the test period. The noticeably better performance at the start of the testing period largely stems from a single month in 1973 where the relative momentum first model had the investor in International stocks while the absolute momentum first model had the investor in bonds.

While one month does matter, we can't ignore the snap back in the following years where the relative momentum first model quickly caught back up.

The performance advantage of Gary's model has shrunk to nothing in the past two decades. I suspect this may be due to the corresponding rise of China and an expanding European Union during this period.

Relative Momentum First or Absolute Momentum First: Japan

Sources: TheRichMoose.com, MSCI Inc., FRED

Japan provides us with a stress test example of a highly diversified, high impact market going through a period where local stocks performed poorly while International stocks did extremely well.

To perform this test, I used the MSCI Japan Index, MSCI Kokusai Index, the MSCI ACWI ex-Japan Index, and Japanese CD data from the Federal Reserve Bank of St. Louis. All momentum evaluations used a 12-month lookback period and all data was priced in Japanese yen.

In this simple backtest, we can clearly see the many periods where Japanese stocks were underperforming CDs. This would put the investor into local bonds when absolute momentum was evaluated first (Gary's method). The investor missed years of International stock market exposure.

However, when doing a relative momentum evaluation first (my method), the investor was able to participate in International stock growth while the local market was underperforming.

In the end, an investor testing the absolute momentum of local stocks first would have realized a reasonable +8.03 percent compound annual return. The same investor testing relative momentum first would have realized a +10.46 percent compound annual return.

As seen by the chart below, the performance advantage for testing relative momentum first was noticeable across most time periods.

Sources: TheRichMoose.com, MSCI Inc., FRED

I acknowledge Japan might be a bit of an anomaly as an enormously inflated stock market going into the late-1980s. However, it does show us a recent example using a very diversified market, one that has a meaningful impact on the global economy, and a country with reserve status currency.


As long as the U.S. economy is the world's leading economy and the U.S. dollar is the base currency for global currency valuations and global economic activity, the method of testing absolute momentum first in the Dual Momentum model should work.

While U.S. stocks and the U.S. economy have performed well this past century and have been a leading indicator of the global economy, this phenomenon is likely to subside as the U.S. declines in relative impact. Just as the U.S. rose to prominence in the early 20th century, China and India are rising today.

Gary's method of evaluating Dual Momentum relies on the performance of U.S. stocks to get exposure to any equities. This limitation in the process needlessly exposes investors to single market risk.

Single market risk is very real. We can see the negative effects of a single market on Dual Momentum when we apply Gary Antonacci's process to Japanese stocks. Although Japan is not the U.S., it is also not a fringe economy with a non-influential currency or small global impact.

Given the shifts we are seeing today, it is not out of the realm of possibility that the U.S. experiences a similar decline in market influence, becoming a market laggard instead of a market leader.

We can significantly reduce our single market risk by slightly changing the Dual Momentum process. Instead of testing absolute momentum on U.S. stocks first, we should start with a relative momentum evaluation on our equity assets. We will still always test for absolute momentum on the better performing equity asset to ensure we are not investing into a declining market.

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Traditional Positions vs. LEAPS Options

Over the past several months, I have made a major shift in how I execute my trades. I still follow trends: betting on the upside when prices are moving up and betting of the downside when prices are moving down; however, I have almost completely avoided taking a traditional position.

By traditional position, I mean buying X many units of XYZ and holding onto that position. Or, on the downside, short selling units of XYZ and holding the position until the trend changes direction.

Instead, I am using LEAPS options (long-dated options) on most of the ETFs I track to execute my trades. I can buy call options to bet on upside movements and I can buy put options to bet on downside movements.

This shift allows my to use my trading capital much more efficiently, reducing my risk exposure and increasing my potential portfolio profits.

Traditional Position Sizing Example

Taking a position in this traditional method amounts to a very inefficient use of capital. Lets use the current price of SPY (the biggest ETF) as an example:

Source: StockCharts.com

Using a simple Keltner Channel indicator, lets say we will enter the trade when it crosses $267 and we'll have a stop at $252. If we have a $100,000 account risking 2 percent of capital per trade, this would be our exposure:

Units = R/(P-S)
R = $100,000 x 0.02
R = $2,000
P = $267
S = $252
Units = $2,000/($267-$252)
Units = 133
Position = Units x P
Position = 133 x $267
Position = $35,511

This means we would have to use more than one-third of our capital to enter this one position for $35,511. This means we only have $64,489 left in our account to add more positions, either limiting our diversification or forcing us to access margin loans.

On the risk side, we will sell our position if the price falls below our stop level of $252, which would result in a loss of $2,000. Our stop will rise if the price of SPY continues to rise, hopefully resulting in a profit before we eventually exit the position.

Understanding Options Contracts

Now, lets look at the exact same trade using LEAPS options. In this case we are betting on the upside; in the wide world of options trading we can execute this trade in two ways: we can buy call options or we could sell put options.

While both trades would bet on the upside, the difference in risk and mindset is extreme!

Source: TheRichMoose.com

When we buy a call option, we are initially in a small but limited loss because we pay a premium for the option contract. However, as we cross the point where the price of the security (in this case SPY) exceeds the cost of the strike price and the premium paid, everything is incremental profit.

In other words, limited and highly controlled downside with very high upside potential.

Source: TheRichMoose.com

When we sell a put option, the premium we collect is the most money we will ever make on that trade: instant maximum profit. If the security (SPY) goes up, we do not collect any more money. However, if the price of the security goes down, we begin to lose money.

If the price of SPY falls below the strike price minus the premium collected, we are showing a loss and the loss will grow incrementally from there if the price of SPY continues to fall.

For this reason I never write (sell) options! I would rather control my downside than my upside. However, the appeal of instant profit when writing options is very alluring so this is a popular strategy for investors to earn income. Unfortunately, many are blind to the risks.

Position Sizing with Call Options Example

In this example, we will take an upside position in SPY using the exact same risk parameters as we did in the previous example. There are many ways to make this trade, but for the sake of simplicity we will use a January 2020 LEAPS option with a strike price at $265—an "at-the-money" option trade.

First, we will need to take a look at the price of the options by viewing the "Options Chain" for SPY:

Source: Marketwatch

We can see here that the price of the option with a strike of $265 is $19.19 today. Now, options must be bought or sold in contracts that are groups of 100 units. So one contract equals exposure to 100 units of SPY.

In this case, we are again willing to risk $2,000. Since we must get exposure to 100 units, one contract would cost $1,919 while two contracts would cost $3,838. Given our risk, should we purchase one or two contracts?

We know our exit point is $252, meaning we will close our position if the price reaches that point. If we buy a single contract, we know that we would never lose more than the premium we initially paid: $1,919. However, can we get more exposure while maintaining our risk?

To get a clue, we can look up the options chain. When SPY is $252, our $265 call option will be $13 out-of-the-money. Today, a call option that is $13 out-of-the-money is valued at $10.85. We can imply that if we sold a two contract position tomorrow, we could recoup $2,170 for a net loss of $1,668.

Given the overall margin of safety and our stop loss level, it is quite safe to purchase two contracts of SPY at a strike price of $265 when executing this trade. Again, that gives us exposure to 200 units of SPY for a total cost of $3,838 (or 3.8 percent of our total capital).

Profit Potential: Traditional vs. LEAPS Options

After extensively looking at our downside risk, we need to compare the end result of a profitable trade. Lets assume the price of SPY rose considerably over the next six months and we receive a signal to exit at $290. How much money would we make?

Traditional Trade

In our traditional trade we purchased 133 units of SPY for $267 per unit for a total outlay of $35,511.

If we sell 133 units at $290 per unit, we will get $38,570 in proceeds (minus trading commissions). That equals a profit of $3,059 on the trade.

Our percent return on capital employed would be +8.61 percent. Our return on our portfolio value would be +3.06 percent.

LEAPS Call Option Trade

In our LEAPS call options trade, we bought two contracts of SPY with a strike of $265 for January 2020. The total outlay, or cost to us, was $3,838.

If we sell two contracts of SPY with about six month left when the price is at $390, we can look at the current call options expiring in June 2019 for a clue on the price. Our options would be $25 in-the-money, so we will consider the current price of a $242 June call option on SPY.

Currently, June call options with a strike of $242 are valued at $29.75. This suggests our options could sell for roughly the same value. (Volatility at that time and the exact number of days remaining before option expiry will impact the true price).

Using these estimates, if we sell our two contracts for January 2020 call options at a strike of $265 when the price of SPY is $290, we could collect $5,950 (minus trading commissions). That equals a net profit of $2,112 on the trade.

Our percent return on capital employed would be +55.03 percent. Our return on our portfolio value would be +2.11 percent.


Using LEAPS options on popular ETFs allows the investor to use their trading capital much more efficiently when taking positions.

Using simple risk metrics, it would not be uncommon for an investor to deploy 25 to 50 percent of their capital on a single trade if they purchased broad index ETFs in the traditional method.

With LEAPS options, an investor may deploy less than 5 percent of their capital to execute a comparable trade on the same security. This allows them to make many more trades without taking on margin debt or other loans.

Traditional purchases of ETFs can allow the investor to make a higher return on their total investment capital. This is because there is no time decay or volatility costs when holding the position. That said, LEAPS options are much more efficient overall when measuring return on capital employed.

Unlike traditional investing where the price is the price, LEAPS options allow for great flexibility in executing trades. Buying deep in-the-money options can significantly reduce time and volatility costs, but will increase total capital outlay (while still being a fraction of the traditional outlay). Using out-of-the-money options will increase time and volatility costs, but can massively increase exposure.

Comments & Questions

All comments are moderated before being posted for public viewing. Please don't send in multiple comments if yours doesn't appear right away. It can take up to 24 hours before comments are posted.

Comments containing links or "trolling" will not be posted. Comments with profane language or those which reveal personal information will be edited by moderator.