Incorporating Macroeconomic Indicators into Momentum Trading

Time series momentum is a trading strategy that involves buying assets that have exhibited upward price trends and selling those that have shown downward trends over a specific time period. The premise is that assets with positive momentum will continue to perform well in the short term, while those with negative momentum will likely continue to underperform. This approach capitalizes on the persistence of market trends, which may be driven by investor behaviour, market inefficiencies, or underlying economic factors.

Traditional time series momentum strategies typically rely solely on price data. Reference [1] proposed incorporating external macroeconomic data into the trading strategy. Specifically, it utilizes GDP, inflation, unemployment rates, and interest rates. The author pointed out,

This research explores the enhancement of traditional momentum trading strategies through the integration of key economic indicators. By incorporating macroeconomic data such as GDP, inflation, unemployment rates, and interest rates, the strategy aims to adapt more effectively to varying market conditions, thus potentially increasing both the stability and profitability of trading outcomes [4].

Our findings suggest that the inclusion of economic indicators provides a more comprehensive view of the market dynamics at play, allowing traders to make more informed decisions that align with both short-term price movements and broader economic trends. This approach not only leverages the inherent strengths of momentum trading but also mitigates its weaknesses by reducing reliance on price action alone

Briefly, the author constructed a composite index consisting of weighted momentum indicators to generate trading signals. The modified strategy shows improvements.

We believe incorporating external macroeconomic data adds value, but we note, however, that the data period used in the study is relatively short, and no out-of-sample testing was performed.

Let us know what you think in the comments below.

References

[1] Mohit Apte, Enhancing Momentum Trading with Macroeconomic Indicators-A Strategic Approach, International Journal of Innovative Research in Computer Science and Technology, 2347-5552, Volume-12, Issue-4, July 2024