Probabilistic Momentum Spreadsheet
In the last post, I introduced the concept of viewing momentum as a probability of one asset outperforming the other versus a binary decision driven by whichever return is greater between a pair of assets. This method incorporates the joint distribution between two assets that factors in their variance and covariance. The difference in the two mean returns are compared to the tracking error between two assets to compute the information ratio. This ratio is then converted to a probability via the t-distribution to provide a more intelligent confidence-based buffer to avoid costly switching. A good article by Corey Hoffstein at Newfound discusses a related concept here. Many readers have inquired about a spreadsheet example for probabilistic momentum which can be found here : probabilistic momentum worksheet.