PDF Summary:Unholy Grails, by Nick Radge

In the high-stakes world of investing, timing and trends are everything. In Unholy Grails, Nick Radge argues that momentum investing—capitalizing on existing upward trends in asset prices instead of trying to predict future movements—offers a more robust and potentially profitable approach than traditional "Buy & Hold" strategies.

The book explores key principles of momentum investing using quantitative analysis and historical simulations. It covers specific momentum strategies, examining their performance through metrics like returns, risk, and win/loss ratios. Radge also discusses the psychological challenges momentum investors must overcome, advocating for discipline, patience, and a long-term mindset.

(continued)...

• Set up a virtual stock portfolio to practice momentum investing without financial risk. Use a stock market simulator to "invest" in stocks that are currently gaining momentum. Monitor your virtual portfolio's performance over time to gain insights into how momentum investing strategies might play out in real life.

"100-day High" Parallels "New Yearly Highs" With a 100-day Lookback

As a more assertive take on the "New Yearly Highs" strategy, the "100-Day Peak" method shortens the lookback period to one hundred days, aiming for quicker entry into developing trends. This approach reflects Radge’s view that entering sooner can enhance returns by capturing trends earlier in their development.

Higher Annualized Returns of 24 Percent With Greater Drawdowns

Simulations demonstrate that the "100-Day Peak" method yields a 23.74% CAGR, exceeding that of the "New Yearly Highs" strategy, reflecting its quicker entry into emerging trends. However, this results in a higher MaxDD (-45.2%), highlighting the trade-off between return and risk often present in momentum strategies.

Other Perspectives

• The "100-Day Peak" method may not be suitable for all investors, especially those with a lower risk tolerance, given the potential for greater drawdowns.
• This method may not be as effective in markets that are range-bound or lacking clear trends, as the strategy relies on the presence of strong trends to be profitable.
• Alternative investment strategies, such as value investing, may challenge the notion that higher returns necessarily come with greater risk.

Index Filter Enhances Risk-Adjusted Performance of 100-Day High Plan

Applying a 75-day "Index Filter" with an immediate exit strategy when the market drops below the filter to the "Hundred-Day High" approach leads to a significant reduction in maximum drawdown. This version of the strategy also produces a higher Sharpe Ratio than the unfiltered version, indicating improved risk-adjusted returns.

Practical Tips

• Set up alerts on a free stock market app to notify you when a stock you're tracking reaches a 75-day high or low. Use this as a cue to review the stock's performance and consider if it aligns with the drawdown reduction strategy. For instance, if you receive an alert that a stock has hit a 75-day low, you might analyze other market factors to decide if it's a temporary dip or the start of a longer trend.

Tested Momentum Trading Methods: "Golden Cross," "MAC," "TechTrader," "20% Pivot"

Radge assesses four additional momentum strategies, each with unique buy and sell rules, highlighting their strengths, shortcomings, and the impact of incorporating an "Index Filter" on their performance.

Unique Buying and Selling Rules With Varied Complexity and Effectiveness

The "Golden Cross" strategy, a popular indicator often mentioned in financial media, buys when a 50-day moving average surpasses a 200-day moving average, signaling potentially bullish momentum. Exits are triggered by a "Death Cross," which happens if the 50-day moving average dips beneath the 200-day moving average. Simulations of this strategy reveal underwhelming performance, as the compound annual rate of growth (11.63%) and MaxDD (-53.7%) are only slightly better than the benchmark. The "Moving Average Channel (MAC)" strategy, developed by Jake Bernstein, forms a price channel by employing two moving averages based on daily highs and lows. This strategy enters a trade when a daily price bar—not just the closing price—remains entirely over the channel for five days in a row. The strategy closes the position after five days in a row below the channel. This approach delivers impressive results with a compound yearly increase rate of 26.76% and a MaxDD of -49.2%.

The "TechTrader" strategy, developed by John Rowland, a non-professional trader, employs multiple rules, including price level, turnover, and a 40-period moving average filter. This strategy, which has a compound annual return rate of 21.33% and a MaxDD of -38.5%, highlights the effectiveness of combining various criteria to identify strong momentum signals, even if developed by someone outside the financial industry. The "20% Flipper" approach, inspired by Martin Zweig's interpretation of Ned Davis's "4% Rule," buys stocks that have risen 20% from a low point in anticipation of further gains and exits when a stock falls 20% from a high point. This straightforward approach, boasting a 30.81% compound growth rate and -35.3% MaxDD, demonstrates the remarkable power of capturing initial momentum swings for superior returns.

Practical Tips

• Engage with a community of novice investors through social media groups or investment forums to share insights and observations about the Golden Cross strategy. By discussing your findings and experiences with others, you can gain diverse perspectives on the strategy's effectiveness and learn from the collective experiences of the group, which can inform your own investment decisions.
• Use a free charting software to visually plot the Moving Average Channel on a stock of your choice. By observing the channel and price interaction over time, you can get a feel for the strategy's entry and exit points, which will help you recognize patterns and improve your decision-making process when you decide to apply the strategy with actual trades.
• Partner with a friend who's also interested in investing and challenge each other to a paper trading competition using the MAC strategy. Set a time frame, such as six months, and see who can achieve the best performance using virtual portfolios. This friendly competition can provide motivation and a learning experience as you discuss and compare your strategies and outcomes.
• Design a personal finance game night where you and your friends create a board game that incorporates investment strategies, including the TechTrader approach. Use dice, cards, and play money to simulate market conditions and investment decisions. This hands-on experience can help demystify the strategy and make the concepts more accessible.
• Develop a habit of reviewing new product launches and technological advancements to spot potential investment opportunities. Attend local trade shows, webinars, or product launch events, even virtually, to get firsthand information on what's new and potentially groundbreaking. For instance, if a company is launching a new AI service that could revolutionize an industry, consider researching and possibly investing in that company.

20% Flipper Strategy Shows Strong Risk-Adjusted Returns

Radge identifies the "20% Flipper" approach as a standout performer due to its remarkable combination of high returns (30.81% compound annual growth rate) and comparatively low max decline (-35.3%), resulting in a MAR ratio of 0.87. According to Radge, this method exemplifies the effectiveness of capturing momentum swings by entering positions after a significant upward move and exiting promptly on substantial reversals. Its robustness is further highlighted by Monte Carlo simulations, which consistently demonstrate high returns relative to risk over 1000 iterations, further solidifying its appeal for momentum investors.

Context

• This metric measures the largest single drop from peak to trough in the value of a portfolio before a new peak is achieved. It is a key indicator of downside risk over a specific time frame.
• A strategy with a high max drawdown might also exhibit higher volatility, which can lead to more significant fluctuations in portfolio value over time.
• The MAR ratio underscores the importance of balancing risk and reward. A strategy with a high MAR ratio is typically more attractive to investors who are risk-averse but still seek substantial returns.
• The time frame for identifying significant upward moves can vary. Short-term traders might look at daily or weekly price changes, while long-term investors might consider monthly or quarterly trends.
• The use of Monte Carlo simulations in the strategy suggests rigorous backtesting, which involves testing the strategy on historical data to ensure its effectiveness across different market scenarios.
• These are computational algorithms that use repeated random sampling to obtain numerical results. They are often used to assess the impact of risk and uncertainty in prediction and forecasting models.

Quantitative Analysis and Validation of Investment Approaches Employing Momentum Strategies

Radge utilizes simulations of historical data, encompassing periods of bullish, bearish, and sideways markets, to rigorously assess and validate how various momentum strategies perform, as discussed throughout the book. He employs key metrics, such as annualized returns, maximum drawdowns, MAR ratio, win rates, and ratios of wins to losses, to quantify the effectiveness of these strategies.

Historic Simulations Validate Momentum Approaches

Radge stresses the importance of backtesting strategies across various market conditions to understand their effectiveness and limitations. He argues that simulations are a means to gain insights into the strategy's performance, its strengths, and weaknesses, ultimately allowing people to make informed decisions.

Simulations Cover Bull, Bear, and Sideways Markets

Throughout the book, Radge conducts tests with historic data from a diverse stock market, encompassing periods of sustained bull markets (like the period leading up to 2007), substantial bear markets (like the financial crisis of 2008), and periods of volatile, sideways price action (like the consolidation seen in 2010-2011). This approach allows for a comprehensive assessment of how the strategies perform under varying market conditions, ensuring their robustness.

Other Perspectives

• Simulations often rely on the quality and completeness of historical data, which may be subject to errors, omissions, or biases.
• The relevance of historical data may diminish over time as market mechanisms and the global economy evolve.
• The selection of historical periods might inadvertently include biases that could affect the perceived robustness of the strategies.
• The robustness of strategies may not take into account the impact of transaction costs, slippage, and taxes, which can significantly affect real-world performance.

Monte Carlo Simulations Assess Stability and Reliability

To address the fundamental shortcomings of single-run backtests, Radge emphasizes employing stochastic modeling. He underscores the importance of understanding the spectrum of potential results instead of depending on one test. Monte Carlo models, by generating thousands of iterations with slight variations in historical data, provide a robust assessment of a strategy's reliability and highlight the potential variability of returns. Radge employs Monte Carlo modeling for every strategy discussed in the book, further solidifying the validity of his findings.

Practical Tips

• Create a simple spreadsheet to track and analyze different scenarios for a major purchase, like a car or home. Input various factors such as loan interest rates, down payment amounts, and maintenance costs, then use random number generation to simulate different market conditions and calculate the outcomes over time. This approach gives you a more comprehensive view of the potential financial impact.
• Implement a 'pre-mortem' analysis for upcoming projects or events. Before starting a new project or attending an important event, take some time to imagine it has failed or didn't go as planned. Write down every possible reason for this failure, no matter how unlikely it seems. This exercise will help you identify potential pitfalls and outcomes you might not have considered, allowing you to take preemptive actions to avoid them.
• Apply the Monte Carlo method to plan for a large personal event, like a wedding or a milestone birthday party. Estimate your budget, guest count, and vendor costs, then run several iterations with slight variations in these numbers using a spreadsheet. This can give you a range of possible outcomes to better prepare for unexpected expenses or changes in your plans.
• Apply the concept of variability to your career planning by mapping out several professional paths with different levels of risk and potential reward. Consider factors like job stability, industry growth, and required education. Then, assess how external factors such as economic downturns or technological advancements could affect these paths. This exercise can help you prepare for and adapt to the unpredictable nature of career development.
• Experiment with project planning by breaking down a complex task into smaller components and estimating the time or resources needed for each. Assign probability distributions to each estimate to account for uncertainty. For example, if you're renovating your kitchen, list out tasks like demolition, electrical work, and cabinetry, and assign a range of days each might take. Use a simple random number generator to simulate different project timelines and identify potential bottlenecks or resource constraints. This can help you plan more effectively and set realistic expectations.

Key Metrics: Annual Returns, Biggest Drawdowns, Mar Ratio, Win Rates, Win/Loss Ratios

Radge introduces and explains several key performance metrics used to assess the effectiveness of the evaluated strategies. He emphasizes the importance of considering both returns and risk when evaluating strategies, advocating for a risk-adjusted approach instead of focusing solely on potential gains.

Strategies Yield Superior Risk-Adjusted Returns Over a Buy-and-Hold Approach

The author consistently compares the simulated performance of the momentum strategies against the XAOA benchmark, representing a Buy & Hold approach. This comparison demonstrates that, across various methods, momentum-based investing generally yields superior returns relative to risk over time, highlighting the benefit of moderating exposure and capitalizing on trends.

Other Perspectives

• The XAOA benchmark may not be the most appropriate comparison for momentum strategies, as it represents a Buy & Hold approach and may not reflect the risk profile or investment universe of the momentum strategies being considered.
• Moderating exposure based on trends can result in missing out on unexpected market recoveries or rallies, as these strategies might move an investor to the sidelines during potential upswings.

Strategies With Higher Win Percentages and Win/Loss Ratios Show Strong, Consistent Performance

Radge emphasizes the importance of a plan's win/loss ratio, highlighting that having a strong win rate isn't necessarily essential for profitability. He demonstrates that approaches with a favorable ratio of wins to losses, where average wins significantly outweigh average losses, can produce strong, consistent performance, even with win rates below 50%, further challenging the common misconception that success in the stock market is about being consistently right. The "20% Flipper" strategy, for instance, consistently shows a win/loss ratio around 3:1 alongside a winning percentage around 40%, consistently outperforming the market in simulations and exemplifying the power of focusing on maximizing wins and minimizing losses, regardless of win rate.

Practical Tips

• Create a "decision tree" for recurring choices to streamline your decision-making process. For decisions you face regularly, such as how to spend your free time or manage work tasks, draw out a flowchart that leads to different outcomes based on various choices. Use this visual aid to guide your decisions, aiming for branches that historically lead to favorable outcomes.
• Create a 'win-loss scale' visual tool to help you balance your trades. Use a physical or digital scale diagram where you can add weights representing the monetary value of wins and losses. This visual representation will help you quickly assess if your wins are compensating for your losses. For instance, after a week of trading, place weights on the scale according to the profits and losses of each trade and see which side tips more.
• Develop a habit of setting aside 20% of your successes for reinvestment into new ventures or learning opportunities. For instance, if you have a side business and it earns a profit, take 20% of that profit and use it to explore new markets or invest in professional development courses. This practice encourages continuous growth and can lead to increased success rates over time.

Psychological and Behavioral Aspects of Successful Momentum Approaches

Radge acknowledges the importance of understanding the psychological hurdles inherent in investing in momentum strategies. He stresses that successful implementation requires overcoming biases, adopting a long-term perspective, and adhering to the system's rules, even during periods of underperformance or drawdowns.

Momentum Investing Requires Overcoming Biases

Radge highlights several common misconceptions about investing in momentum, advocating for a more objective and rational approach. He emphasizes the dangers of relying on predictions and the need to surrender to the inherent unpredictability of financial markets.

Investors Should React to Market Trends Instead of Predicting Movements

Radge reiterates his core message—that momentum investors react to existing price trends instead of attempting to anticipate future market movements. He emphasizes that no strategy can guarantee perfect timing, and that focusing on prediction can lead to significant losses, as illustrated by Warren Buffett's unfortunate investment in ConocoPhillips. He encourages investors to accept the market's randomness and focus on identifying existing trends, allowing the "stocks to pick them," rather than the other way around.

Practical Tips

• Diversify your investment learning by following a 'theme of the month' approach, where you focus on understanding a different aspect of investing each month. For example, one month could be dedicated to learning about index funds, another to real estate investments, and another to commodities. This helps you build a broad knowledge base and reduces the risk of making predictions based on a narrow understanding of the market.
• Develop a habit of flipping a coin to make minor, inconsequential decisions in your daily life to get comfortable with randomness. This could be for choices like picking a restaurant or selecting a movie to watch. The goal is to desensitize yourself to the anxiety of unpredictable outcomes, making it easier to handle the randomness of the market.

Cut Losses Swiftly, Let Profits Run Despite Fluctuations

Radge underscores the importance of adhering to the system's rules for managing risk and establishing positive expectations. He stresses the need to cut losses swiftly to minimize negative impacts, even when it feels counterintuitive, while letting profits run to take advantage of the complete extent of a movement, even when tempted to secure early gains. He advocates for managing unprofitable trades—by controlling losses—rather than always seeking profitable ones, acknowledging the unpredictability of outcomes while focusing on effectively handling risk.

Practical Tips

• Use a "three-strikes" rule for daily decisions and purchases. If a new item or activity doesn't meet your expectations three times, take action to remove it from your life. For instance, if a subscription service fails to impress you on three separate occasions, cancel it immediately to avoid further disappointment and financial drain.
• Try implementing a "Plan B Day" once a month where you intentionally choose alternative options for your usual activities. This could mean eating at a new restaurant, trying a different workout, or even using a new app for productivity. The goal is to see firsthand how outcomes can vary and to learn to adapt to and appreciate the unexpected results that come from these changes.

Patience and a Long-Term Outlook Essential for Momentum Strategies

Radge emphasizes that using momentum strategies isn't a “get-rich-quick” scheme but rather a long-term approach that relies on exploiting an advantageous expectation over numerous transactions. He advocates for a patient and disciplined approach, acknowledging that those who persist through both favorable and unfavorable conditions will be rewarded by the market.

Remain Committed to Your Approach, Trust Your Advantage

Radge stresses the importance of maintaining a long-range perspective and sticking with a proven strategy, even during periods of drawdowns or underperformance. He argues that doubting the plan and overriding its guidelines—a common mistake among novice investors—often leads to poor outcomes and reinforces negative behavioral patterns.

He reminds readers that averages will eventually work in their favor if they have a favorable expected value, and that short-term performance fluctuations are an inevitable part of the process. He encourages investors to trust the edge, emphasizing that consistent application of the strategy will ultimately result in superior returns that factor in risk, compared to traditional ‘Buy & Hold’ approaches.

Practical Tips

• Implement a "strategy buddy" system where you pair up with someone who shares a similar long-range goal. Meet or communicate regularly to discuss your strategies, progress, and challenges. This partnership can provide accountability and support, helping both of you to stay committed to your proven strategies. For instance, if you're both aiming to run a marathon, you can share training plans, celebrate each other's long runs, and encourage sticking to the plan when motivation wanes.
• Set up a "Commitment Contract" with a friend or family member where you agree to follow through with your plan without deviations for a set period. If you break the agreement, there's a predetermined consequence, such as donating to a charity or doing a chore you dislike. This adds a layer of accountability and deters you from doubting your plan since there's something at stake.
• Use a "Habit Reward Calculator" to reinforce positive habits. Assign an expected value to each habit based on the long-term benefits and likelihood of those benefits occurring. For example, assign daily exercise a high expected value due to the high probability of improved health and mood. Track your consistency with these habits in a calendar or app, and as you accumulate days of adherence, calculate the cumulative expected value to motivate continued commitment.
• Develop a personal "Performance Fluctuation Plan" that outlines specific actions to take when you notice a dip in performance. This could include short breaks, change of scenery, or a quick physical activity to re-energize. If you're working on a project and hit a slump, your plan might involve stepping away for a 10-minute walk to clear your mind.
• Develop a "Consistency Calendar" where you track one small, trust-building action you take each day. This could be as simple as always responding to emails within a certain time frame or making sure to give credit to others in team meetings. Over time, these actions will become habits, reinforcing the idea that consistency in behavior builds trust.
• You can track your investment performance by creating a personalized dashboard using free online tools like Google Sheets or Excel. Start by logging your investment buys and sells, noting the dates, prices, and reasons for your decisions. Over time, you'll be able to analyze patterns in your strategy's performance compared to a simple buy-and-hold approach. For example, if you notice that your active management is outperforming during certain market conditions, you can refine your strategy to capitalize on these insights.

Emotional Management and System Adherence: Key Challenges For Momentum Investors

Radge acknowledges the significant challenges associated with managing emotions and maintaining discipline when implementing momentum approaches.

Cultivating a Strategic Mindset Helps Investors Stay Committed

The author offers practical advice to help investors overcome the psychological obstacles inherent in a momentum investment approach. He advocates for surrendering to market unpredictability, emphasizing the futility of making forecasts. He encourages understanding the concept of an edge and its long-term benefits, focusing on the "next thousand transactions" rather than individual outcomes. Radge promotes a calm and patient approach, reminding investors that significant accomplishments, like profitability in momentum investing, require time and consistent effort. He encourages investors to separate themselves from the daily fluctuations of their account value, emphasizing the growth potential over time of a positively expectant strategy.

He stresses the importance of adhering to the system's rules, even when it feels uncomfortable, particularly during losing streaks or when previously earned profits are lost. Radge acknowledges that these emotional challenges are real and significant, but argues that cultivating a strategic mindset, focusing on the system's edge, and adopting a long-range perspective are crucial for successfully navigating these hurdles and ultimately achieving financial success through momentum-based investing.

Practical Tips

• Use dollar-cost averaging as a strategy to invest a fixed amount of money at regular intervals, regardless of the market's performance. This technique can help you avoid the temptation to forecast market highs and lows and instead build your investment portfolio steadily over time.
• You can identify your personal edge by creating a 'Future Resume'. Write a resume as if it's five years from now, including skills and achievements you aspire to have. This helps you visualize long-term goals and understand the edge you need to develop. For example, if you see yourself as a leader in your field, you might list speaking engagements or certifications you plan to earn, which will guide your current learning and networking efforts.
• Engage in a monthly reflection session where you review your actions and their outcomes. Set aside time at the end of each month to look back on the decisions you've made and their results. This practice will help you understand the compound effect of your actions. For instance, if you're learning a new language, reflecting on the hours spent practicing can motivate you by showing the incremental improvements in fluency.
• Create a "market mood" journal to track your emotional responses to market changes. By documenting how you feel when the market goes up or down, you can begin to notice patterns in your emotional reactions. This self-awareness can help you avoid making impulsive decisions based on short-term emotions, fostering a more patient and calm approach to investing.
• Use a "set it and forget it" approach by automating your investment contributions and only checking your account quarterly. By doing this, you distance yourself from the daily ups and downs that can trigger emotional responses. For example, set up automatic transfers to your investment account and delete or hide the app from your phone to resist the temptation to check it.
• Create a "Growth Book Club" with friends or colleagues where each member picks a book or resource that focuses on personal development. The twist is, instead of just discussing the content, each member commits to a specific growth goal related to the topic and shares updates at each meeting. This social accountability can reinforce a positively expectant attitude towards personal growth.
• Create a "Rule Adherence Journal" to document your experiences following system rules, especially when it's challenging. Each day, write down the rules you adhered to, the discomfort you felt, and the outcomes of your actions. This practice will help you reflect on the benefits of consistency and may reveal patterns in your behavior and the system's functionality.
• Set up a 'cooling-off' period for all investment decisions, where you wait a predetermined amount of time before acting on an investment impulse. During this period, engage in an activity unrelated to investing, like going for a walk or meditating, to clear your mind. This can prevent emotional knee-jerk reactions and promote more rational decision-making.
• Create a 'future journal' to practice strategic foresight. Each day, spend a few minutes writing down potential future scenarios in your personal or professional life, and how you might respond to them. This exercise can help you develop a strategic mindset by encouraging you to think ahead and prepare for different possibilities. For instance, if you're concerned about job security, you might outline steps to enhance your skills or build a professional network.
• Create a visual timeline of your financial goals to maintain a long-term perspective. Start by plotting out your major financial milestones on a timeline that spans several decades. This could include buying a house, funding education, retirement, and any other significant investments. By physically seeing the long-term trajectory of your financial life, you'll be more inclined to make investment decisions that align with these milestones rather than getting caught up in short-term market fluctuations.