Following Strength, Cutting Weakness: The Logic Behind Relative Momentum

Why We Don’t Predict Markets and What We Do Instead

In our previous article, Emotional Investing Is Expensive, we explored how emotion quietly undermines long-term investment outcomes. Panic during downturns, overconfidence during rallies, and the constant urge to “do something” often prove more damaging than the market itself.

But removing emotion from investing is not simply about trying to stay calm. It requires a structure that makes emotional decision-making unnecessary in the first place.

At Pathwise Wealth, that structure is a systematic, data-driven strategy known as Relative Momentum.

Moving From Prediction to Process

Most investment approaches begin with a forecast. What will interest rates do? Where is inflation heading? Which sector should outperform?

Relative Momentum begins somewhere else entirely.

Rather than predicting economic conditions or interpreting geopolitical headlines, it focuses on observable price behaviour. The market reflects the collective judgement of millions of participants. Instead of trying to outguess that judgement, we measure it.

Each month, the top 100 Australian companies are ranked based on their relative strength. The portfolio holds the five companies demonstrating the strongest confirmed trends. If a holding weakens relative to the market, it is removed. If broader conditions deteriorate significantly, the portfolio can move to cash.

The strategy does not rely on conviction. It relies on evidence.

Accepting That We Won’t Always Be Right

No disciplined strategy promises perfection.

Historically, a meaningful proportion of signals will not result in gains. Relative Momentum accepts this reality. Being wrong is not the problem. Staying wrong is.

When a trend weakens, positions are exited decisively. When strength persists, winners are allowed to run. Over time, this creates asymmetry: gains from sustained trends outweigh the smaller losses from failed signals.

The edge is not found in a high strike rate. It is found in disciplined risk management.

Why We Don’t “Buy the Dip”

A common investing instinct is to look for bargains. When prices fall sharply, the temptation is to step in early.

However, markets often decline further and for longer than expected. Attempting to catch falling assets can amplify losses rather than reduce them.

Relative Momentum does not attempt to identify market bottoms. It favours assets that have already demonstrated confirmed upward strength. While this can feel counterintuitive, decades of market data suggest that established uptrends tend to persist longer than most expect.

Instead of guessing where weakness ends, the strategy waits for strength to reveal itself.

Concentration With Discipline

The strategy typically holds five companies at any one time. At first glance, this may appear less diversified than traditional portfolios.

But risk is not defined solely by the number of holdings. It is defined by how actively exposure is managed.

Positions are reviewed monthly. Underperforming holdings are removed. Exposure can be reduced materially when trends across the market deteriorate. Historical modelling using data extending back to the mid-1990s demonstrates that during severe market dislocations, the strategy would have shifted largely to cash, avoiding prolonged exposure to deep downturns.

The Limits of Forecasting

Forecasting markets is appealing. It provides the illusion of control.

Yet long-term studies consistently show that the majority of active managers fail to outperform the broader market after fees over extended periods. Even with significant research resources and expertise, accurately predicting future outcomes year after year is extraordinarily difficult.

Relative Momentum does not attempt to out-predict the market. It responds to it.

Instead of asking what we believe will happen next year, it asks what the market is rewarding today; and adjusts accordingly.

Peter and Stan’s Philosophy

Markets will always be uncertain. Headlines will always be dramatic. Volatility is not an anomaly. It is a feature of investing.

The difference between costly investing and disciplined investing is not intelligence or access to information. It is structure.

Relative Momentum replaces reactive judgement with a repeatable framework. It follows strength. It cuts weakness. It steps aside when conditions deteriorate.

It does not rely on confidence, conviction, or prediction.

Because while being wrong occasionally is inevitable, allowing emotion to repeatedly influence decisions is far more expensive. And over time, structure is what protects capital from that cost.

Speak with our team to understand how a systematic, evidence-based portfolio could work for your goals and risk profile.