The Model Guide
A Comprehensive Guide to the Momentum and Reversal Model
A warm welcome to all new subscribers and, of course, to my existing readers. I know that some of you have been eagerly awaiting a more detailed guide and description of my models. Well, here it is.
This guide will give you a good manual on how to read my charts, which will hopefully help you form your own views. I am also planning to produce a short video tutorial for those of you who like me to walk you through it in my own vocals.
To give you more context, I also want to provide a bit more history of how and why I developed those models, which are just a subset of other models I am also using. Some of them are for shorter time frames and intra-day-specific trading strategies. I will make those models available once I figure out how to program them into TradingView.
I have built and relied on those models for large parts of my investment career, especially after the GFC world, where additional diversification by trading varying time frames became necessary. As you have probably read in my below piece on technical analysis, I only started using the “dark arts” after the great financial crisis.
The crux of it is to keep it simple. Thinking and taking advice from more experienced investment professionals at that time, I followed the more natural path, which for macro trading is usually the bulk of one’s PnL. Namely momentum.
Momentum, derived from the Latin word "movimentum," meaning movement, is a fundamental concept that permeates every facet of the universe, from celestial bodies hurtling through space to the ebbs and flows in someone’s life. Its universality is a testament to its primal nature. The universe, for example, offers a vivid tableau of momentum at work. Planets orbit stars, galaxies drift apart, and cosmic particles dash through space, all due to momentum. Newton's First Law of Motion — often paraphrased as "an object in motion stays in motion" — highlights that unless acted upon by an external force, objects continue their motion. This persistent, inherent tendency to maintain motion gives a glimpse into momentum's foundational role in shaping the cosmos.
Closer to home, Earth's ecosystems also present instances of momentum. For instance, river water flows consistently, eroding paths and carving valleys over millennia. Evolution, too, is a manifestation of biological momentum where species adapt and progress over generations, driven by the cumulative momentum of minor changes. Simply put, nature seems wired to favour and harness momentum, often building on existing paths and patterns.
Human psychology isn't immune to momentum, either. Concepts such as the "bandwagon effect," where individuals adopt certain behaviours due to the perceived momentum or popularity behind them, attest to our inherent attraction to trends. This inclination isn't a mere coincidence; it's possibly an evolutionary adaptation, favouring decisions that align with a prevailing trend for safety or efficiency.
Given the pervasive nature of momentum, it's unsurprising that it finds resonance in financial markets. Here, momentum investing becomes a strategy where investors buy assets trending upwards and sell those on a downward spiral. But what underlies this strategy?
Trend Recognition: Just as rivers carve valleys, assets, too, move in discernible trends. Over time, prices that start rising (or falling) can continue that trajectory due to various factors, including market sentiment, narratives, or macroeconomic indicators.
Behavioural Finance: Our psychological inclination towards momentum also plays out in markets. Investors, driven by FOMO (Fear of Missing Out), may jump onto trending stocks, propelling them further.
Reflexive Loops: In financial markets, momentum often feeds on itself. As more investors notice a trend, they join in, further intensifying it, creating a self-sustaining feedback loop, much like the snowball effect. This reflexive move has the potential to shape reality and, by this, open up new areas of possibilities which haven’t previously been priced.
It is, however, crucial to approach momentum with caution. Just as cosmic bodies require external forces (like gravity) to alter their trajectories, financial trends can reverse due to unforeseen events. This is why I have paired a momentum model with one that looks at the existing trend in force and analyses it for its strength and stability. Typically, a trend ends and then ultimately reverses.
This is also found in natural and cosmic laws as we move in cycles. Tides, governed by the gravitational interplay between the Earth, moon, and sun, showcase a constant ebb and flow. Similarly, economies don't grow perpetually; they face periods of expansion and contraction. Just as tides can be influenced by external factors like wind or atmospheric pressure, economic tides can sway due to policy changes, global events, or technological breakthroughs.
Nature's seasons — spring, summer, autumn, and winter — evoke the cyclical shifts in market sectors. There are times when a particular sector blooms (like tech in the digital age or renewables in the green transition) and times when they recede, making way for another sector's growth. As seasons change due to the Earth's axial tilt, market seasons shift due to changing consumer preferences, technological evolutions, or regulatory environments.
These two models give us the needed awareness to train our observing self to sense and exploit the momentum shifts and exhaustion, and reversals over time, free of narratives and biases.
For all subscribers, I would recommend the following quick guide, which should give you enough information if you ever see my charts on here or over at Twitter.
Let’s now look at some details.