In the last article, we demonstrated that momentum-based systematic strategies perform significantly better in digital asset markets than in traditional ones, driven in large by the structural characteristics of the asset class.
We also noted the inherent constraint that long momentum strategies are regime-dependent and accumulate large drawdowns in unfavorable conditions.
Now let’s dive into how to structurally resolve that constraint.
The Structural Limitation of Long-Only Exposure
Even well-constructed long momentum strategies operate within a narrow set of market conditions. Bitcoin’s price history illustrates the point. Over the last five years, it closed above its 50-day high only 5% of the time. Strong upward trending conditions (the conditions long breakout strategies require) are the exception, not the norm.
Outside of trending conditions, long-only systems are either minimally exposed, flat, or absorbing drawdowns. Let’s take another look at the equity curve of the long momentum strategy shown in the previous email:
To reiterate, this is not a strategy failure. It is the natural behavior of a basic long momentum system in a bear regime. To resolve this constraint, we need to introduce strategies that bet on the opposite direction of long momentum strategies.
The Role of Short Systematic Strategies
Short systematic strategies serve two distinct functions in a portfolio context:
- Return generation in bear regimes: Capturing negative market beta during sustained downward trends that long-only portfolios sit through
- Volatility reduction: Reducing portfolio volatility as well as the depth and duration of drawdown periods.
To illustrate, below is an example of one of our momentum-short strategies that is designed to identify sustained bearish momentum and hold exposure through the trend:
Long + Short: The Combined Effect
Combining a long trend strategy with a short trend strategy creates a portfolio that generates returns across opposing market regimes. The performance below shows both strategies applied together:
The return correlation between the two strategies is structurally near-zero:
| Returns Correlation | Momentum Long | Momentum Short |
|---|---|---|
| Momentum Long | 1.00 | -0.06 |
| Momentum Short | -0.06 | 1.00 |
A correlation of -0.06 between the two strategies indicates a modest but meaningful degree of diversification: periods of weaker performance in long strategies have historically tended to coincide with more supportive performance from short strategies, and vice versa. By maintaining exposure to both upward and downward trending regimes, the portfolio can operate with shallower drawdowns, a smoother equity curve, and more consistently deployed capital across changing market environments.
There remains, however, a third market regime where neither long nor short momentum strategies are typically well positioned: extended sideways conditions. In the next article, we address how mean reversion strategies address this gap.