Directives
Jan 10, 2026
System: Simple Momentum
New subsystem for SOVEREIGN
by CelestialEye | Quantitative Systems Engineer
A Longer Period Exploration
After the previous exploration of shorter period momentum, we now want to take a closer look at longer period momentum.
For the combined momentum system, we again utilize four sub-systems.
The Two Main Directional Sub-Systems
They utilize a regime filter (only trade long when the market goes up; for short, when the market goes down).
Furthermore, a volatility filter is implemented, enabling signals only in high or low volatility periods but not the "muddy middle" volatility regime.
This way, it trades only during compressions or already playing out elevated volatility periods.
A volatility filter of this kind allows it to mostly avoid the range-bound, choppy period.
Entry is defined as a short lookback trend signal triggering.
Pink is long; Cyan is short; Orange is the combined Directional System.
The Complementing Bi-Directional Sub-System
Volatility Filter: Trade only in the “muddy middle.”
Counter-Trend Filter: Trade long only when the market is going down; short only when the market is going up.
Entry: On a “whipsaw” pattern (above → below → above).
This strategy works during the “muddied middle” type of volatility where momentum signals tend to be weaker but can still be utilized. This is also a situation where a clear definition of momentum or mean reversion is not fully applicable, as the distinction between them fades and then relies on the exact implementation.
Purple is Long; Pink is Short; Blue is the Combined Complementing System.
Together, we get the directional system in orange, the complementing system in blue, and the final combined system in red.
Introducing the "SMO" System: Diversification and Resilience
In the strategy itself, a significant part of this system is dedicated to adding beneficial diversification during periods of momentum and choppy markets.
While it is not the most desirable system as a standalone strategy, in combination, it covers many of the portfolio's blind spots.
For simplicity, this system is termed "SMO".
The correlation structure that SMO adds is highly advantageous.
The Advantage of Independent Bets for Portfolio Health
The strength of the combined system is confirmed when looking at the independent bets statistics.
What we see here is that with 5 systems, we have ~4.6 independent bets.
This means that each system contributes additional returns that prior systems cannot explain or account for.
A simple example for understanding: If we have two trend-following long systems, they will both bring returns at essentially the same time, meaning their number of independent bets will be somewhere at 1-1.2 (to account for a bit of noise/signal variance).
This shows that they would provide returns at the same time and encounter drawdowns at the same time, which leads to worse general risk-adjusted return behavior and an unfavorable return distribution.
With 5 systems at 4.6 independent bets, the portfolio exhibits significantly stronger diversification and resilience compared to a scenario with two trend-following long systems, resulting in roughly 1.2 independent bets.
Comparison of System Behavior
Feature | 5 Systems (~4.6 Independent Bets) | 2 Systems (~1.2 Independent Bets) |
|---|---|---|
Diversification | Very high. Each system's returns are largely uncorrelated with the others. | Very low. Systems are highly correlated, likely trading the same way at the same time. |
Return Contribution | Returns are provided consistently across different market environments by different systems. There is always some system providing returns. | Returns are concentrated, occurring only when the specific market environment (e.g., strong long trend) is present. |
Drawdowns | Severe Drawdowns are mitigated. When one system enters a drawdown, the others, which are driven by different factors and regimes (momentum, counter-trend, different volatility states), are likely still generating returns or less affected. | Drawdowns are magnified. Both systems encounter drawdowns at essentially the same time, leading to deeper and more painful portfolio losses. |
Risk-Adjusted Return | Favorable. The smoothing effect of diversification leads to a higher Sharpe ratio, better Calmar ratio, and a generally better risk-adjusted return profile. | Worse. High correlation means risk is not diversified away, leading to lower risk-adjusted returns and a poorer distribution of returns. |
Return Distribution | Smoother, more consistent equity curve. Less volatile return streams due to non-synchronous performance. | Choppy and volatile equity curve. Periods of high returns followed by simultaneous, deep drawdowns. |
Key Takeaway: Mitigating Risk with Non-Correlated Systems
The key takeaway is that the 4.6 independent bets ensure that the risk of simultaneous failure across all components is much lower, protecting the portfolio during adverse market conditions for any single strategy type.
In contrast, 1.2 independent bets confirm redundancy, meaning that the portfolio would be vulnerable to the exact same risks on two fronts.
Overview