Momentum Basket Strategy

For a 20-stock equal-weight basket, you need enough to buy meaningful positions in each. With C$5,000 per stock, you'd need C$100,000 minimum. For an options/futures implementation with leverage, C$50,000 could work. Smaller capital can use a Canadian momentum ETF such as the Morningstar Canada Momentum Index ETF (WXM) as a simpler alternative.

Research shows short-term reversal - stocks that jumped in the last month often pull back slightly. By skipping the most recent month, we capture the medium-term trend (months 2-12) while avoiding the short-term reversal. This improves signal quality.

Momentum crashes occur when previous winners suddenly become losers (and vice versa). This typically happens during market regime changes, crises, or sector rotations. The basket can drop 20-30% quickly. Risk management (stops, volatility scaling) helps limit damage during crashes.

Yes, a Canadian momentum-factor ETF such as the Morningstar Canada Momentum Index ETF (WXM) provides exposure to the momentum factor with lower effort. However, a custom basket allows more control over sector caps, position sizing, and rebalancing rules. Index/ETF-based is simpler; a custom basket allows optimization.

Monthly rebalancing is standard - it captures momentum rotation without excessive turnover. More frequent (weekly) increases costs too much. Less frequent (quarterly) may miss momentum shifts. Monthly balances signal capture with cost efficiency.

Screen for momentum first (top 50 by 12-1 return), then filter for quality (ROE > 15%), value (PE < 40x), or low volatility. The remaining stocks have momentum plus other favorable characteristics. This multi-factor approach improves risk-adjusted returns and reduces crash risk.

Price momentum uses stock returns (12-month price change). Earnings momentum uses fundamental data (EPS revisions, earnings surprises). Both predict future returns but capture different information. Combining them provides more robust signals than either alone.

Use buffer zones (exit at rank 30 not 20), threshold rebalancing (only trade if drift >3%), and consider bi-monthly instead of monthly rebalancing. These can reduce turnover by 30-50%, saving 1-1.5% annually in transaction costs.

Equal weight is simpler and more diversified - each stock contributes equally to performance. Momentum weight allocates more to highest momentum stocks, potentially higher returns but more concentrated. Start with equal weight; graduate to momentum weight if comfortable with concentration risk.

Primary benchmark is the universe index (S&P/TSX Composite). Secondary is a Canadian momentum-factor index/ETF (e.g., the Morningstar Canada Momentum Index / WXM) for direct momentum comparison. Calculate alpha (excess return), tracking error, and information ratio. You should beat the universe index; compare to the momentum index for implementation quality.

Combine signals: 12-1 return (30%), 6-1 return (20%), 52W high (15%), earnings revision (15%), revenue acceleration (10%), technical indicators (10%). Convert each to z-scores, apply weights, sum for composite. Walk-forward test to validate weights out-of-sample.

Gradient boosting (XGBoost, LightGBM) handles mixed features well. Use time-series cross-validation (not random split). Features: returns, volatility, fundamentals, technicals, sector. Target: top quartile next month or predicted return. Ensemble with traditional for robustness.

Monitor warning indicators: narrowing momentum dispersion, extreme value spread, weakening breadth, rising VIXC. Implement regime-based allocation (reduce exposure when warnings elevate). Buy OTM puts for tail hedge (1-2% cost). Have clear exit rules for crash scenarios.

Core-Satellite: 50-60% in diversified index (core), 20-30% in momentum (satellite), rest in other factors/cash. Kelly criterion suggests 20-25% optimal allocation. Rebalance between core and satellite to maintain allocation. Monitor correlation - if too high, reduce momentum allocation.

Futures: Partial basket in futures frees capital for RF return (4-5% extra). Covered calls: On mature momentum stocks for income. Protective puts: 8-10% OTM on index for crash protection (1-2% annual cost). Synthetic: Options combinations reduce capital requirement. Balance leverage with crash risk.