Shepherd's momentum: a brief introduction

In this blog I briefly introduce our proprietary Shepherd's momentum indicator. Many of the financials concepts used here will be familiar to the expert investor but, as usual, I aim to make my blogs both accessible to beginners and engaging for experienced investors.

The Shepherd's momentum indicator is a twist on the traditional exponentially weighted moving average (EWMA) crossover indicator.

Typically the EWMA crossover indicator is calculated as follows:

• Calculate two EWMA: one with a short parameter and other with a long parameter.
• When the short EWMA crosses the long moving average from below, that is taken to mean that the prices are increasing and signals that the investor should buy. Conversely, the short EWMA crossing the long moving average from above is a sell signal.

The Shepherd's momentum is defined between -1 and 1. A value of 1 would mean full long and a value of -1 fully short. Values in between indicate that only part of the available capital will be invested.

The following graph shows, as an example, the bitcoin price together with a fast Shepherd's momentum signal calculated on this price.

The position (number of units to be bought or sold) is generally given by: position = signal x capital / price, where signal is a value between -1 and 1. For instance, a signal of 0.5 would mean buy an asset in a quantity equal to half of the available capital.

Going short or taking a short position essentially means selling an asset. Short selling is a trading strategy used to profit from falling prices. There are two primary ways to short a financial asset:

• Borrowing the assets from a broker.
  • The trader borrows the asset from a broker and sells it on the open market.
  • Later, they buy it back at (hopefully) a lower price and return it to the broker.
  • This method incurs costs such as interest on the borrowed asset and broker fees.
• Selling futures contracts.
  • Instead of borrowing, traders can sell futures contracts, which are agreements to sell an asset at a fixed price on a future date.
  • If the asset’s price declines, they can buy back the contract at a lower price and pocket the difference.
  • Futures trading also involves costs, including broker commissions and exchange fees.

For examplee, traders who expect bitcoin's price to drop can short it by either borrowing and selling Bitcoin or by selling Bitcoin futures, such as those available on the Chicago Mercantile Exchange.

Additionally, some investors prefer using inverse Exchange-Traded Funds (ETFs), like ProShares Short S&P500 which aim to deliver the opposite return of an asset (similar to going short) without requiring direct short selling.

It is entirely possible, and even maybe advisable, to use the SM indicator without short selling:

• Set the signal to zero, if SM is less or equal than zero.
• If investors either want to be out of the market or fully invested, then the signal can be set to 0 if SM less or equal to 0, and to 1 if SM is greater than 0 and less or equal to 1.

There are a few points to have in mind:

• This blog is not an invitation to trade. Also does not intend to provide trading advice.
• Trading involves risks, and readers are solely responsible for their trading decisions.
• Trading imvolves costs like: commissions, slippage, interest. Slippage is the difference between the trade's desired price and the price at which the trade is actually executed.
• Losses, when investing in leveraged products like futures, options and leveraged ETFs, may exceed the original investment's value.