Turn of the Month Effect in Futures Momentum Strategy

Turn of the Month (TOM) is a well-known effect in equity markets connected with buying pressure from mutual and pension funds that move stock prices. Usually, one anomaly can be found in various asset classes and not in the only one where it was originally discovered. Academic research shows that the turn of the month effect isn’t limited just to equity markets. Additionally, in the universe of futures, there seems to be a link between momentum or trend-following strategies and the turn of the month days.

This research shows that a major part of the returns of trend-following strategies is realized during three days around the turn of the month. Since these momentum strategies during the TOM days have digested sizeable inflows, managers tend to scale up the portfolio they were already holding at the time. Naturally, the aforementioned causes a buying pressure from systematic trend-following/momentum CTA funds, which results in a movement of futures prices from various sectors – commodities, rates, currencies and equities in their favor.

The whole idea could be easily exploited by employing the trading strategy that trades only during these three days. The main improvement compared to traditional momentum strategies is that such an approach leads to better risk-adjusted returns than common trend-following/momentum strategies.

Fundamental reason

The fundamental reason for the functionality is deeply connected with buying pressure. Momentum strategies during the turn of the month days have digested sizeable inflows, which causes that managers tend to scale up the portfolio they were already holding at the time. Another possibility is that managers simply do their portfolio rebalancing at the end of the month. However, in both cases, the aforementioned causes a buying pressure from systematic trend-following/momentum CTA funds, which temporarily moves prices of underlying futures in the same direction and causes this effect.

Additionally, the combined momentum and turn of the month effect reverses partially over the subsequent period (non-turn of the month days), which could be expected from a temporary price pressure. This anomaly is much stronger for illiquid commodities, what again, is in line with the hypothesis and also could be expected. Last but not least, the paper has shown that the combined anomaly cannot be simply explained by a turn of the month effect in passive long positions.

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Markets Traded
bonds, commodities, currencies, equities

Financial instruments
CFDs, futures

Confidence in anomaly's validity
Strong

Backtest period from source paper
2000-2014

Notes to Confidence in Anomaly's Validity

Indicative Performance
4.8%

Period of Rebalancing
Daily

Notes to Indicative Performance

per annum, annualized return = 12 x 0.4% (estimated 3-day return during ToM period, data from figure 5)


Notes to Period of Rebalancing

Estimated Volatility
1.5%

Number of Traded Instruments
52

Notes to Estimated Volatility

estmated from IR ratio 3.23 from table 2


Notes to Number of Traded Instruments

Maximum Drawdown
0%

Complexity Evaluation
Complex strategy

Notes to Maximum drawdown

Notes to Complexity Evaluation

Sharpe Ratio
3.2

Simple trading strategy

The investor constructs replicating index utilizing 52 liquid futures (5 currencies, 20 commodities, 17 equity indices, 10 fixed income). Investor uses time-series momentum strategy where he calculates 100-day SMA indicator scaled by securities volatility for each future contract. 100-day SMA signalizes long/short signal and portfolio of futures is volatility weighted. Investor then holds this portfolio only during 3-day period around turn of the month. More than 50% of total return of time-series momentum strategy is realized during ToM period and resultant ToM momentum strategy has much higher risk adjusted return than original strategy.

Source paper
Van Hemert: The MOM-TOM Effect: Detecting the Market Impact of CTA Trading
- Abstract

Motivated by the explosive growth in CTA assets under management, in combination with the recent poor performance of many managers in this sector, we explore whether the trend-following trading style employed by many CTAs has become crowded. Explicitly, we test for market impact using the following hypothesis: around the turn of the month (TOM), trend-following (MOM) strategies digest sizeable inflows, causing the managers to trade up their existing positions, thereby pushing prices temporarily in their favor. The main empirical test is whether there is an above average return for MOM strategies on TOM days, which we refer to as the MOM-TOM effect. We found a very strong MOM-TOM effect in the Newedge Trend Index returns, with 90% of cumulative returns since 2000 being realized on the three TOM days. In addition, a replicating strategy we designed to closely track the Newedge Trend Index displayed a strong MOM-TOM effect.

Strategy's implementation in QuantConnect's framework (chart+statistics+code)
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