Momentum investing

Momentum investing is a system of buying stocks or other securities that have had high returns over the past three to twelve months, and selling those that have had poor returns over the same period.[1][2]

While no consensus exists about the validity of this strategy, economists have trouble reconciling this phenomenon, using the efficient-market hypothesis. Two main hypotheses have been submitted to explain the effect in terms of an efficient market. In the first, it is assumed that momentum investors bear significant risk for assuming this strategy, and, therefore, the high returns are a compensation for the risk.[3] Momentum strategies often involve disproportionately trading in stocks with high bid-ask spreads and so it is important to take transactions costs into account when evaluating momentum profitability.[4] The second theory assumes that momentum investors are exploiting behavioral shortcomings in other investors, such as investor herding, investor over and underreaction, disposition effects and confirmation bias.

Seasonal or calendar effects may help to explain some of the reason for success in the momentum investing strategy. If a stock has performed poorly for months leading up to the end of the year, investors may decide to sell their holdings for tax purposes causing for example the January effect. Increased supply of shares in the market drive its price down, causing others to sell. Once the reason for tax selling is eliminated, the stock's price tends to recover.

Some investors may react to the inefficient pricing of a stock caused by momentum investing by using the tool of arbitrage.

History

Richard Driehaus is sometimes considered the father of momentum investing but the strategy can be traced back before Donchian.[5] The strategy takes exception with the old stock market adage of buying low and selling high. According to Driehaus, "far more money is made buying high and selling at even higher prices." [6]

In the late 2000s as computer and networking speeds increase each year, there were many sub-variants of momentum investing being deployed in the markets by computer driven models. Some of these operate on a very small time scale, such as high-frequency trading, which often execute dozens or even hundreds of trades per second.

Although this is a reemergence of an investing style that was prevalent in the 1990s,[7] ETFs for this style began trading in 2015.[8]

Effectiveness

In a study in 1993 Narasimhan Jegadeesh and Sheridan Titman reported that this strategy give average returns of 1% per month for the following 3–12 months.[9]

The performance of momentum comes with occasional large crashes. For example, in 2009, momentum experienced a crash of -73.42% in three months.[10]

See also

References

  1. ↑ "Momentum Investing Definition | Investopedia". Investopedia.
  2. ↑ Low, R.K.Y.; Tan, E. (2016). "The Role of Analysts' Forecasts in the Momentum Effect". International Review of Financial Analysis. doi:10.1016/j.irfa.2016.09.007.
  3. ↑ Li, Xiaofei; Miffre, Joelle; Brooks, Chris; O'Sullivan, Niall (2008). "Momentum profits and time-varying unsystematic risk". Journal of Banking & Finance. 32 (4): 541–558. doi:10.1016/j.jbankfin.2007.03.014. ISSN 0378-4266.
  4. ↑ Li, Xiaofei; Brooks, Chris; Miffre, Joelle (2009). "Low-cost momentum strategies". Journal of Asset Management. 9 (6): 366–379. doi:10.1057/jam.2008.28. ISSN 1470-8272.
  5. ↑ Antonacci, Gary (2014). Dual Momentum Investing: An Innovative Approach for Higher Returns with Lower Risk. New York: McGraw-Hill Education. pp. 13–18. ISBN 0071849440.
  6. ↑ Schwager, Jack D.. The New Market Wizards: Conversations With America's Top Traders. John Wiley and Sons, 1992, (pg. 224), ISBN 0-471-13236-5
  7. ↑ Waggoner, John (September 9, 2016). "Momentum investing gaining speed among financial advisers". Investment News. Retrieved November 2, 2016.
  8. ↑ "Comparing Investor Options in the Momentum ETF Space". ETF Daily News. September 21, 2016. Retrieved November 2, 2016.
  9. ↑ Jegadeesh, N.; Titman, S. (1993). "Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency". The Journal of Finance. 48: 65. doi:10.1111/j.1540-6261.1993.tb04702.x. JSTOR 2328882.
  10. ↑ Barroso, Pedro; Santa-Clara, Pedro (April 2015). "Momentum has its moments". Journal of Financial Economics. 116 (1): 111–120. doi:10.1016/j.jfineco.2014.11.010.

Further reading

  • Soros, George, 1987, The Alchemy of Finance, Simon and Schuster, New York.
  • Tanous, Peter J., 1997, Investment Gurus, New York Institute of Finance, NJ, ISBN 0-7352-0069-6.
  • Antonacci, Gary, 2014, Dual Momentum Investing: An Innovative Approach for Higher Returns with Lower Risk, McGraw-Hill Education, New York, ISBN 0071849440
  • The Definitive Guide To Momentum Investing and Trading, Signal Plot, August 24, 2017
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