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Trading in the financial markets is a complex task, and even professional investors often find it challenging to outperform the market consistently. In Taiwan’s equity market, investors often face the dilemma of whether to ride rising trends or avoid purchasing at peak prices.
This article presents a structured momentum strategy designed to identify and capture stocks with strong upward trends. Through detailed backtesting, we evaluate the strategy’s performance, providing a valuable reference for quantitative researchers and practitioners.
Our approach selects the top 200 stocks by market capitalization to ensure that the chosen assets are highly liquid and less susceptible to manipulation by large institutions. This selection reduces the risk of excessive volatility while providing sufficient depth for trading.
After selecting the stock pool, we calculate the closing prices of each stock over the past quarter (with the time period adjustable based on specific needs) to assess their mid-term momentum. Then, choose the stocks with the strongest momentum. This approach helps capture the trends of strong performers in the market.
The momentum strategy adopts a simple yet disciplined approach, consisting of the following steps:
• Entry：On the first trading day of each month, buy the stock with the highest momentum from the previous period.
• Exint：Sell the stock on the last trading day of the month or earlier based on predefined stop-loss or take-profit conditions.
To eliminates the need for continuous market monitoring. Orders are placed just before the market closes, minimizing intraday noise
At the end of month, we calculate the momentum from the previous period, and then on the first trading day of the new month, we buy the stock with the highest momentum one minute before the market closes. We sell it one minute before the market closes on the last trading day of the month.
Additionally, the strategy includes a slippage function to simulate the impact of transaction costs due to price friction when placing orders. This design is both simple and effective, making it suitable for investors who prefer not to engage in frequent trading.
Using TEJ data, we backtested the strategy with an initial capital of 10 million TWD, covering the period from January 1, 2019, to August 15, 2024. The Taiwan Stock Exchange Weighted Index served as our benchmark for performance comparison.
Below is a summary of the core backtest logic:
Performance Overview
Although the strategy presents significant profit potential, it also entails considerable risk. The strategy successfully captured major opportunities, such as the 2021 rally in Yang Ming Marine Transport, which contributed substantially to the overall performance.
In the drawdown ratio chart, it’s evident that this strategy exhibits significant volatility, frequently experiencing large drawdowns. The most substantial drawdown occurred recently in August 2024, during a sharp decline in the Taiwan stock market, where the strategy’s drawdown reached 50%.
This chart compares the cumulative returns of the strategy against the broader market under similar volatility conditions, providing a way to assess the strategy’s relative performance at the same risk level. Before June 2021, the strategy underperformed the market, but once it captured a significant profit opportunity, its performance quickly turned around. Notably, even as the broader market experienced a downtrend in 2022, the strategy remained stable and successfully avoided this decline. Therefore, despite the higher volatility of this strategy, its overall performance advantage still surpasses that of the broader market.
Next, we will analyze the results with only take-profit, only stop-loss, and with both take-profit and stop-loss conditions, and examine why the returns vary under these different settings.
Our tests revealed that setting a take-profit at 30% reduced returns slightly, but the overall trajectory remained consistent with the unrestricted strategy. However, overly conservative thresholds (e.g., 20%) caused the strategy to underperform the broader market by limiting exposure to high-growth opportunities. Conversely, setting the take-profit above 40% did not yield significant additional returns, as stocks typically experienced corrections before reaching these levels.
Setting a take-profit does indeed help reduce volatility risk, but as the analysis above shows, the choice of take-profit level significantly impacts performance. While we can identify the optimal take-profit during backtesting, predicting this ‘best take-profit point’ in real trading is not easy. Although risk is controlled, the charts reveal that the unrestricted strategy typically yields higher returns than the strategy with a take-profit. This suggests that even if risk is not effectively controlled, the strategy can still achieve substantial returns by capitalizing on a few significant price surges. Therefore, if I were to implement this strategy in real trading, I might choose not to set a take-profit point, as doing so could potentially miss out on the core value of the strategy—capturing explosive returns from high-volume, strong-performing stocks.
Our tests revealed that setting a take-profit at 30% reduced returns slightly, but the overall trajectory remained consistent with the unrestricted strategy. However, overly conservative thresholds (e.g., 20%) caused the strategy to underperform the broader market by limiting exposure to high-growth opportunities. Conversely, setting the take-profit above 40% did not yield significant additional returns, as stocks typically experienced corrections before reaching these levels.
Finally, we attempted to apply both take-profit and stop-loss as dual exit conditions.
The dual exit strategy, incorporating both take-profit and stop-loss conditions, resulted in smoother equity curves and reduced volatility. Although the returns were slightly lower than the unrestricted version, this approach may suit investors with lower risk tolerance.
The analysis of the momentum strategy raises a crucial question: Does the trend remain? This strategy focuses on capturing the momentum of stocks, particularly those with significant short-term gains. Through rigorous backtesting, it has been observed that selecting stocks with the highest momentum can yield substantial profits. However, this comes with inherent risks, as these stocks may have already peaked or be subject to increased volatility.
The backtesting results indicate that while the strategy can deliver impressive returns—often exceeding the broader market—its performance is highly influenced by the chosen take-profit and stop-loss levels. Findings suggest that a more flexible approach to these exit conditions may enhance overall performance. Specifically, a take-profit set between 30% and 50% and a stop-loss set at around 15% could strike a balance between capturing gains and mitigating losses.
“Taiwan stock market data, TEJ collect it all.”
For researchers and investors looking to refine their trading strategies, access to high-quality data is paramount. TEJ’s comprehensive databases provide essential insights and historical performance data, facilitating the development and backtesting of such quantitative strategies. By leveraging these resources, users can better navigate the complexities of market dynamics and optimize their trading decisions.
