Momentum Investing

How are momentum stock trading strategies doing these days? In their January 2006 paper entitled “The Vanishing Abnormal Returns of Momentum Strategies and ‘Front-running’ Momentum Strategies”, Thomas Henker, Martin Martens and Robert Huynh examine the returns of various momentum trading strategies in general and during specific market conditions (rising or falling) over the period 1993-2004. They construct a series of self-financing portfolios (equal-weighted) for various holding periods by buying past winners and selling past losers based on various past performance (ranking) periods. Some strategies include a one-month gap between the ranking and holding periods. They repeat portfolio construction monthly over the sample period for each strategy, resulting in overlapping portfolios. Finally, they test “front-running” strategies that set momentum rankings five days before the ends of months rather than at month-ends. Using daily data to calculate monthly returns for a broad sample of stocks (with all distributions reinvested), they find that: Keep Reading

Value and momentum are two very different equity investing styles, both with many adherents. Neither outperforms the overall market all the time. Is there some systematic way of combining these two approaches to enhance consistency of outperformance in global equity markets? In their March 2006 paper entitled “Generating Excess Returns through Global Industry Rotation”, Geoffrey Loudon and John Okunev examine different investing styles (momentum, value, combination of value and momentum, and growth) to exploit cyclic industry returns, with the U.S. yield curve as the critical economic indicator. Using monthly global prices, dividends, earnings and returns data for 36 industries for 1973-2005, they conclude that: Keep Reading

We have selected for retrospective review a few all-time “best selling” research papers of the past few years from the General Financial Markets category of the Social Science Research Network (SSRN). Here we summarize the February 1999 paper entitled “Daily Momentum And Contrarian Behavior Of Index Fund Investors” (download count almost 1,900) by William Goetzmann and Massimo Massa. The authors investigate the existence and profitability of momentum and contrarian behaviors for stock index trading. They classify return momentum investors (trend followers) as those who buy (sell) when the market rises (drops) in the previous trading session, and return contrarian investors as “profit takers” who sell (buy) when the market rises (drops). They also examine investor response to changes in market volatility, defining both volatility momentum traders (risk chasers) and volatility contrarian traders (risk avoiders). Using daily activity records for 91,000 accounts trading an S&P 500 index during 1997 and 1998, the authors find that: Keep Reading

In their September 2005 paper entitled “Acceleration Strategies”, Eric Gettleman and Joseph Marks examine the change in six-month stock price momentum (a second derivative of price with respect to time, which the authors call “acceleration”) for individual companies as a potential indicator of future performance. Does increasing (decreasing) stock price momentum indicate commensurate relative outperformance (underperformance)? Based on monthly data spanning 1926-2003, they conclude that: Keep Reading

In the February 2005 update to his paper entitled “The Disposition Effect and Under-reaction to News”, Andrea Frazzini tests whether the “disposition effect” (the tendency of investors to sell stocks that have gone up, not down, in value since purchase) causes stock prices to under-react to bad news when most current holders face a capital loss and under-react to good news when most current holders face a capital gain. Using a database of the holdings of a large class of investors (mutual funds) to estimate reference prices for individual stocks, he ranks stocks according to unrealized capital gains/losses and correlates this ranking with response to corporate news and subsequent return. Based on data spanning 1980-2002, he finds that: Keep Reading

In their June 2005 paper entitled “Momentum Profits and Macroeconomic Risk”, Laura Liu, Jerold Warner and Lu Zhang examine the connection between momentum returns and the overall economy, using the growth rate of industrial production as a proxy for the economic trend. They use monthly data for a large selection of common stocks listed on the NYSE, AMEX, and NASDAQ from January 1960 to December 2001 to construct ten equally weighted momentum portfolios, ranking on past six-month returns and holding for six subsequent months. They find that: Keep Reading

In their July 2005 paper entitled “Momentum Profits and Non-Normality Risks”, Ana-Maria Fuertes, Joelle Miffre and Wooi Hou Tan examine the distributions of returns for nine momentum investing strategies as they attempt to explain why the resultant portfolios outperform. These nine strategies consist of overlapping portfolios formed monthly that are long (short) the equally weighted tenth of stocks with the highest (lowest) return over the past 3, 6 or 12 months and held for the next 3, 6 or 12 months. Using monthly data for all NYSE, AMEX and NASDAQ stocks priced over $5 during February 1973 through August 2004, they find that: Keep Reading

In their May 2005 paper entitled “Asset Fire Sales (and Purchases) in Equity Markets”, Joshua Coval and Erik Stafford examine the effects on stock prices of mutual funds forced to sell (buy) because of predictable outflows (inflows) of funds based on their past performance. Does such forced selling and buying present predictable opportunities for front-running? By studying mutual fund transactions caused by capital flows from 1980 to 2003, they conclude that: Keep Reading