Dorsey Wright Money Management
790 E. Colorado Blvd, Suite 808
Pasadena, CA 91101
626-535-0630
John Lewis, CMT
August, 2014
Implementing Point and Figure RS Signals
Relative Strength, also known as Momentum, is one
successful over the years is using Point and Figure
of the premier investment factors and has proven to
(PnF) analysis to determine momentum. We can
be extremely robust over time. Using momentum as
classify stocks into baskets based on their interme-
a selection criteria means you are looking for securi-
diate and longer term momentum characteristics
ties that have outperformed the broad market or the
using PnF signals. We discussed this methodology
rest of the securities in the universe. Momentum
in our June, 2014 whitepaper titled, “Point and Fig-
looks for strength, and it is a trend following method-
ure Relative Strength Signals.” In that study we
ology. There are numerous studies showing momen-
demonstrated that holding a basket of stocks on
tum works well as a selection criteria within many dif-
PnF buy signals and in a column of X’s (positive
ferent markets (U.S. equities, foreign equities, com-
long and intermediate term relative strength) was
modities, etc…) and across markets (asset alloca-
superior to any other PnF configuration, the S&P
tion). As long as there is dispersion in the universe,
500, and an equal weighted return of all the securi-
momentum tends to work well over time.
1
ties in our universe (please see Appendix 1 for details). Point and Figure relative strength signals are
The most common definition of momentum is using a
a solid method for determining momentum rankings
time based window. For example, the trailing 12
within an equity universe.
month price return for each security in your universe
would be calculated, and then the securities with the
One major difference between PnF relative strength
highest trailing returns would be selected. The mo-
and traditional momentum methods is the element
mentum anomaly exists at the intermediate term time
of time. As mentioned above, momentum is an in-
horizon so most successful strategies will use a time
termediate term factor. PnF, on the other hand,
window of about 3 to 12 months. At intervals less
strips time out of the equation and looks only at the
than 3 months, momentum models are affected too
volatility of the securities. In our July, 2014 whitepa-
much by short term market noise. Very long term
per titled, “Point and Figure Relative Strength Box
intervals, like 3 to 5 years are affected more by mean
Sizes,” we explored using different box sizes for
reversion than momentum.
PnF relative strength analysis. Using a small box
size allows smaller movements to affect the PnF
There are several ways to calculate relative strength
chart, while using larger box sizes means larger
or momentum. One way we have found to be very
moves must occur before there is a change to the
1
The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value.
chart. Much like a time based momentum measure,
was always fully invested with 50 securities, and
there is a sweet spot in the box size that picks up
each month those 50 stocks were equal weighted.
the intermediate term trend while filtering out short
We created 100 different portfolios using this meth-
term noise. Appendix 2 details the returns from us-
odology so we wound up with 100 different equity
ing various box sizes for the same universe of secu-
curves. The securities were different from portfolio
rities. For a universe comprised solely of domestic
to portfolio, but each portfolio held only stocks on a
equities, the best returns were generated using box
PnF buy signal and in a column of X’s.
sizes in the 6.5%-7.5% range. As the box size got
smaller or larger, the returns decreased.
Before discussing the results of the simulations, it is
valuable to look at the length of time securities re-
The results from these previous studies used a uni-
mained eligible for the portfolio. If securities only
verse of U.S. common stocks that were ranked in
remain in the BX basket for a couple of weeks or
the top 1000 by market cap. Both of these studies
months, the turnover might be too high to implement
provided good guidelines on how to use PnF as a
the strategy. The table below gives a summary of
tool to create momentum rankings, but they didn’t
all the PnF baskets over the course of the entire
shed any light on what happens within each basket.
test. The performance listed in the table is relative
From a practical standpoint, it is difficult for most
to the S&P 500 Total Return Index so it didn’t matter
investors to purchase a basket of stocks that con-
if the security was in the BX basket during a bull or
tains 250 or more securities. Does taking a small
bear market. Stocks in the BX basket outperformed
subset of the highest ranked securities perform well
the broad market by about 5% and they are held
over time, or does the investor need to purchase
280 calendar days on average. Obviously, there is
everything in order for the strategy to work? To an-
tremendous variation in both of these numbers, but
swer that question, we created numerous portfolios
the averages indicate that using PnF signals to form
that purchased securities at random instead of pur-
momentum portfolios is very implementable. It is
chasing the entire basket.
also interesting to note that as the momentum ranks
get worse, so do the relative performance numbers.
The methodology to create the random portfolios is
very straightforward. We used the same overall uni-
Signal
Column
Rel Perf
Days
classified each security into one of four baskets (BX,
Buy
X
5.32%
280
BO, SX, SO) based on PnF relative strength. On
Buy
O
0.45%
164
the start date of the test, we drew 50 securities at
Sell
X
0.31%
132
random from the stocks with the best PnF relative
Sell
O
-1.48%
175
verse of securities from the previous studies and
strength ratings (BX). The next month, any of the
50 securities that remained on a BX configuration
remained in the portfolio, and all of the other securi-
Exhibit 1 contains the summary data for the 100 tri-
ties were sold. For each security that was sold we
als of randomly drawn portfolios. The green dot on
drew one security at random from the BX basket
the chart signifies the return of the S&P 500 Total
that wasn’t already in the portfolio. The portfolio
Return Index. The small red bar is the average re-
Examples presented herein are for illustrative purposes only and do not represent past recommendations. Past performance is not indicative of future results. Potential for profits is accompanied by
possibility of loss.
The performance information presented is the back-tested performance of non-investable indexes. Investors cannot invest directly in an index. Indexes have no fees. Back-tested performance is hypothetical (it does not reflect trading in actual accounts) and is provided for informational purposes to illustrate the effects of this strategy during a specific period. Back-tested performance results have
certain limitations. Such results do not represent the impact of material economic and market factors might have on an investment advisor’s decision making process if the advisor were actually managing client money. Back-testing performance also differs from actual performance because it is achieved through retroactive application of a model investment methodology designed with the benefit of
hindsight.
Exhibit 1: Random Portfolio Returns
turn for the 100 portfolios for the given year, and the
be clear that “blow ups” don’t destroy the returns
box denotes the upper and lower quartile bounds of
of a momentum process. The process is robust
the returns. The whiskers on the end of each box
enough to take care of those situations as long as
extend out to the minimum and maximum return for
you remain disciplined. The real problems come
each year.
when you lose focus and allow stocks with poor
momentum characteristics to remain in the portfo-
The first thing to notice is that all 100 portfolios out-
lio.
performed the broad market over the entire test period. The S&P 500 Total Return was up about 802%
Looking at the data in Exhibit 1, it is also important
while the lowest returning trial was up 1,364%.
to keep in mind that while these strategies outper-
Even the most unlucky portfolio outperformed the
formed over the entire test period there were cer-
broad market. If you had an average performing
tainly periods where the momentum factor didn’t
portfolio you did significantly better than the broad
perform as well as the broad market. These peri-
market at about 2,324%. This clearly demonstrates
ods generally occur when there are major changes
the robustness of using PnF relative signals to form
in leadership, or there is a lack of definable leader-
momentum portfolios. Even drawing securities at
ship. These periods are not uncommon, and any
random from a basket of highly ranked momentum
momentum based strategy will go through them.
stocks delivers outperformance over long periods of
The tests we ran did nothing to attempt to combat
time.
this problem. We simply kept the system in place
and waited for the new leadership to be rotated in
One of the reasons we were able to generate out-
to the portfolios. There may be ways to alleviate
performance on all 100 trial runs is the discipline of
some of the performance lag experienced by trend
the implementation. Each month, securities that
following strategies whenever there are changes in
didn’t qualify were sold and new securities that qual-
leadership, but those regime switching models are
ified were added to each portfolio. A momentum
very difficult to implement. While it is very uncom-
strategy is constantly pushing the portfolio toward
fortable for investors, we have found that patience
strength. There is never a time when a weak securi-
and adhering to the strategy are the best ways to
ty is held because we were waiting to get back to
deal with periods of underperformance.
even or some other reason. There is a tremendous
opportunity cost in not constantly cutting out weak
One additional major point many investors fail to
securities. The process also never excluded any
realize is the tremendous amount of difference in
security because it was too volatile, had gone up too
the returns of the 100 portfolios in the same year.
much, or some similar reason. Strong stocks were
In a year such as 1995, about 50% of the portfoli-
added to the portfolio in a systematic and disciplined
os outperformed the broad market and 50% under-
fashion based solely on the momentum ranks.
performed. All 100 trials used the exact same mo-
There were plenty of securities that declined signifi-
mentum process and universe of securities so it is
cantly or “blew up” while we held them. Looking at
hard to believe that is possible. There is an ele-
the long term results of our random trials it should
ment of luck in the outcomes of the process. Is
one portfolio better than the other because it per-
over the long haul.
formed better for a year or two? Clearly not. The
focus should be on the process because the out-
Momentum is a very powerful investment factor.
comes are so difficult to control. There may be
Point and Figure relative strength charts can be
things you can do to narrow the range or improve
used to determine which securities have superior
the outcomes, but there will always some variation
momentum. There will always be uncertainty in
in the returns. It is important to keep this in mind
the outcomes of a momentum process in the short
when looking at any historical testing. If we ran just
term, but a disciplined application of the strategy
one test that happened to be the highest returning
gives investors a high probability of outperfor-
test of the 100, our strategy would look much better
mance over time. When using a PnF relative
than it really is. That is why examining the overall
strength model, you always want to purchase se-
process and the possible range of outcomes is so
curities with the best momentum characteristics
important. Small variations in historical performance
and sell underperforming securities very quickly. It
are often the result of chance rather than one sys-
is very possible to do this when selecting a small
tem being superior to another. The disciplined ap-
subset of high momentum stocks from a much
plication of the method is what drives the returns
larger basket .
Disclosures
Nothing contained herein should be construed as an offer to sell or the solicitation of an offer to buy any se-curity. This report does not attempt to examine all the facts and circumstances which may be relevant to any company, industry or security mentioned herein. We are not
soliciting any action based on this document. It is for the general information of clients of Dorsey, Wright & Associates, LLC (“Dorsey, Wright
& Associates”). This document does not constitute a personal recommendation or take into account the particular investment objectives,
financial situations, or needs of individual clients. Before acting on any analysis, advice or recommendation in this document, clients should
consider whether the security or strategy in question is suitable for their particular circumstances and, if neces-sary, seek professional advice. Dorsey, Wright & Associates, its officers, directors, partners and/or other associated persons may own, hold options, rights or warrants
to purchase some of the securities or assets mentioned in this report, or close equivalents. Even if Dorsey, Wright & Associates does not
currently hold the asset, it may in the future. Dorsey, Wright & Associates may elect to buy or sell these assets or change its opinion without
regard to this report, and without prior notice. The price and value of investments referred to in this document, if any, and the income from
them may go down as well as up, and investors may realize losses on any investments.
This report is based on public information that we consider reliable, but we do not represent that it is accurate or complete, and it should not
be relied on as such. Opinions expressed herein are our opinions as of the date of this document. We do not intend to and will not endeavor
to update the information discussed in this document.
The projections or other information in the attached document regarding the likelihood of various investment outcomes are hypothetical in
nature, do not reflect actual investment results and are not guarantees of future results. Results may vary with each use and over time. The
outcomes in this document are based on historical market data and are presented to illustrate the relative strength strategy. These outcomes cannot be relied upon in the face of changing market conditions, and should be re-evaluated frequently.
The performance information presented is the result of back-tested performance. Back-tested performance is hypothetical (it does not reflect trading in actual accounts) and is provided for informational purposes to illustrate the effects of relative strength during a specific period. The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value. Relative Strength is a measure of price momentum based on historical price activity. Relative Strength is not predictive
and there is no assurance that forecasts based on relative strength can be relied upon.
Back-tested performance results have certain limitations. Such results do not represent the impact of material economic and market factors
might have on an investment advisor’s decision making process if the advisor were actually managing client money. Back-testing performance also differs from actual performance because it is achieved through retroactive application of a model investment methodology designed with the benefit of hindsight. Dorsey, Wright & Associates believes the data used in the testing to be from credible, reliable sources,
however; Dorsey, Wright & Associates makes no representation or warranties of any kind as to the accuracy of such data. All available data
representing the full platform of investment options is used for testing purposes.
Appendix 1: PnF Box Size Returns
Date
12/29/1989
12/31/1990
12/31/1991
12/31/1992
12/30/1993
12/30/1994
12/29/1995
12/31/1996
12/31/1997
12/31/1998
12/31/1999
12/29/2000
12/31/2001
12/31/2002
12/31/2003
12/31/2004
12/30/2005
12/29/2006
12/31/2007
12/31/2008
12/31/2009
12/31/2010
12/30/2011
12/31/2012
12/31/2013
BX
BO
SX
SO
SPXTR
Univ EQ Wt
-0.65%
55.53%
13.33%
14.55%
-4.61%
37.58%
24.57%
35.71%
20.65%
45.86%
1.95%
-12.38%
-13.64%
33.58%
21.24%
12.51%
17.14%
16.68%
-33.82%
29.25%
23.71%
2.45%
15.15%
36.36%
-9.76%
27.72%
11.23%
18.46%
-3.57%
32.04%
17.12%
26.64%
12.09%
20.99%
-3.47%
7.21%
-18.47%
42.38%
17.67%
6.55%
15.20%
3.15%
-41.22%
38.20%
28.19%
-0.69%
21.01%
35.23%
-10.45%
44.97%
17.23%
7.99%
-2.61%
20.95%
10.18%
18.34%
6.61%
5.57%
-9.84%
-3.74%
-30.86%
56.32%
20.81%
5.13%
8.77%
10.13%
-45.32%
61.16%
19.28%
-7.04%
12.31%
40.88%
-18.85%
43.41%
23.87%
14.86%
-2.67%
29.73%
16.02%
21.62%
4.31%
5.55%
-13.15%
-1.07%
-34.65%
69.01%
10.87%
5.48%
16.17%
-1.87%
-47.66%
78.71%
25.84%
-7.47%
16.16%
33.03%
-3.10%
30.47%
7.62%
10.59%
0.85%
37.58%
22.96%
33.36%
28.58%
21.04%
-9.10%
-11.89%
-22.10%
28.68%
10.88%
4.91%
15.79%
5.49%
-37.00%
26.46%
15.06%
2.11%
16.00%
32.39%
-10.60%
46.73%
15.44%
14.62%
-3.68%
32.47%
18.65%
26.92%
10.75%
17.23%
-4.90%
-2.59%
-17.12%
41.06%
19.14%
10.21%
16.29%
8.34%
-39.75%
44.08%
24.95%
-0.27%
16.69%
36.31%
1077.71%
10.81%
19.27%
0.56
526.84%
7.94%
24.33%
0.33
591.50%
8.38%
28.25%
0.30
773.88%
9.44%
18.65%
0.51
1234.94%
11.39%
20.39%
0.56
Cum
2461.28%
Ann
14.45%
St dev
20.49%
Sharpe (Rf=0)
0.71
All Performance numbers are based on the back-tested performance of non-investable indexes. Investors cannot invest
directly in an index. Indexes have no fees. Please see the final page for important disclosures regarding back-tested
performance. Examples presented herein are for illustrative purposes only and do not represent past or present recommendations. Past performance not indicative of future results. Potential for profits accompanied by possibility of loss.
Appendix 2: PnF Box Size Returns
Date
12/29/89
12/31/90
12/31/91
12/31/92
12/30/93
12/30/94
12/29/95
12/31/96
12/31/97
12/31/98
12/31/99
12/29/00
12/31/01
12/31/02
12/31/03
12/31/04
12/30/05
12/29/06
12/31/07
12/31/08
12/31/09
12/31/10
12/30/11
12/31/12
12/31/13
Cum
Annual
St Dev
1.50%
2.50%
3.50%
Point And Figure Box Size
4.50%
5.50%
6.50%
7.50%
8.50%
9.50%
10.50%
-9.1%
44.1%
15.3%
12.5%
-6.6%
23.0%
14.5%
19.8%
5.7%
18.2%
-19.3%
-17.6%
-14.8%
34.5%
15.8%
11.3%
16.4%
16.7%
-41.8%
30.0%
21.5%
-0.2%
13.0%
38.9%
-3.1%
47.3%
12.8%
11.7%
-5.8%
30.9%
14.3%
23.9%
7.5%
33.6%
-4.3%
-16.0%
-14.6%
32.9%
18.3%
11.7%
15.8%
19.3%
-38.3%
31.9%
24.0%
2.4%
12.8%
37.4%
-2.3%
50.9%
13.2%
12.7%
-6.7%
33.9%
17.9%
29.2%
14.7%
38.6%
2.8%
-14.7%
-14.0%
31.5%
18.7%
12.6%
15.7%
18.2%
-34.9%
29.2%
23.3%
2.6%
13.9%
38.2%
-2.2%
52.7%
14.6%
13.3%
-5.4%
34.8%
21.2%
32.3%
16.9%
36.6%
6.9%
-14.0%
-14.6%
33.0%
19.2%
13.0%
16.1%
17.8%
-33.2%
29.6%
24.2%
2.4%
13.0%
38.7%
-3.9%
55.4%
11.8%
13.6%
-5.6%
37.7%
23.4%
34.1%
19.3%
46.9%
1.3%
-11.8%
-13.6%
33.9%
21.6%
13.4%
16.9%
16.1%
-34.2%
27.0%
24.3%
2.8%
15.5%
35.2%
-4.5%
54.9%
10.5%
13.9%
-5.3%
37.5%
23.5%
33.2%
20.3%
45.9%
3.0%
-13.1%
-13.1%
33.6%
22.3%
13.3%
16.3%
16.5%
-35.3%
26.8%
24.8%
3.0%
15.2%
35.0%
-4.7%
44.5%
8.2%
10.1%
-6.3%
38.1%
23.8%
36.8%
23.9%
36.8%
0.1%
-12.7%
-13.5%
31.5%
19.1%
15.4%
15.1%
16.6%
-37.7%
24.9%
22.3%
3.2%
16.3%
34.2%
-0.1%
53.3%
14.3%
13.9%
-5.0%
36.1%
21.3%
32.5%
20.4%
42.0%
3.2%
-13.2%
-14.4%
34.7%
19.9%
13.7%
15.7%
16.0%
-33.3%
28.9%
24.3%
3.2%
13.5%
38.2%
-0.7%
55.5%
13.3%
14.6%
-4.6%
37.6%
24.6%
35.7%
20.6%
45.9%
2.0%
-12.4%
-13.6%
33.6%
21.2%
12.5%
17.1%
16.7%
-33.8%
29.2%
23.7%
2.4%
15.1%
36.4%
-2.4%
55.8%
12.1%
14.5%
-5.0%
37.3%
24.1%
34.2%
20.1%
49.4%
1.7%
-12.6%
-12.7%
33.6%
21.1%
13.3%
17.4%
16.8%
-33.4%
28.0%
24.7%
2.5%
15.1%
36.9%
542.3% 1104.6% 1627.3% 2002.2% 2216.8% 2461.3% 2444.5% 2206.6% 2137.1% 1610.4%
8.1%
10.9%
12.6%
13.5%
14.0%
14.5%
14.4%
14.0%
13.8%
12.5%
20.1%
19.6%
19.6%
19.6%
19.9%
20.5%
20.7%
20.6%
20.6%
19.7%
All Performance numbers are based on the back-tested performance of non-investable indexes. Investors cannot invest directly in an index. Indexes have no fees. Please see the final page for important disclosures regarding back-tested performance. Examples presented
herein are for illustrative purposes only and do not represent past or present recommendations. Past performance not indicative of future
results. Potential for profits accompanied by possibility of loss.