Momentum Finished?

November 2, 2011 Brainwave
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CXO Advisory highlights an interesting paper with the tagline: “Momentum Not Working?”

Here’s the link:

http://www.cxoadvisory.com/subscription-options/?wlfrom=%2F17440%2Fmomentum-investing%2Fmomentum-not-working%2F

Here is the link to the source:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1951137

This work inspired me to run the Size, Value, and Momentum factors through our systems and see what has happened over the past few years.

  • All returns are from Ken French’s website.
  • MOM=L/S Momentum=”Momentum factor”
  • SMB=L/S Size=”Size Factor”
  • HML=L/S Value=”Value Factor”
  • 1/1/2001–12/31/2010

Returns:

  • Size and value worked.
  • Momentum was working, then fell off a cliff.
17
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Market Cycles:

  • Value got killed in the 2008 debalce
  • Momentum got killed in the post 2008 runup
18
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Drawdowns:

  • Momentum: UUUUGGGLLLLYYY!
  • Value/size did a fairly good job preserving capital relative to the SP 500
19
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Risk/Reward:

  • Market=Mediocre at best.
  • Value=Good to go.
  • Size=Good to go.
  • Momentum=Terrible.
20
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Conclusions:

Momentum returns are a lot like Bill Miller’s returns: they were on an epic winning streak, but gave almost all the gains back in a short period of time. My hunch is that momentum can still add alpha over the long haul, but the trick is finding a way to capture the alpha, without dying in the short-term. All the short-term volatility is likely due to the fact that momentum is a very crowded trade among quants–every pitchbook I’ve seen from a quant involves some form of momentum.

 

 

 



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About the Author

Wesley R. Gray, Ph.D.

Dr. Gray has been an active participant in financial markets for over 15 years. His experience includes positions as a Captain in the United States Marine Corps, as a finance professor at Drexel University, and as a portfolio manager for a special-situations hedge fund. Education and entrepreneurship has been the focus of his professional endeavors and his research interests are focused on the performance of portfolio managers and behavioral finance. Dr. Gray is currently the Executive Managing Member of Alpha Architect, an SEC-Registered Investment Advisor. Dr. Gray has published two books: EMBEDDED: A Marine Corps Adviser Inside the Iraqi Army and QUANTITATIVE VALUE: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors. His work has been highlighted on CNN, NPR, Motley Fool, WSJ Market Watch, CFA Institute, Institutional Investor, and CBS News. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.


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  • scrilla_gorilla

    I have thought a lot about this issue and done quite a bit of backtesting on momentum. I’ve come to the conclusion that the key to exploiting momentum is risk control. (That is true in any speculative strategy, but especially for momentum.) In other words, the key to profitably exploiting momentum is not to focus on the “buy” model, but the focus on the “sell” model to prevent large losses when momo stocks inevitably fall back to Earth.

    Even when run as a long-short strategy, momentum is a strategy where stops or intra-period exit points are necessary.

  • Turnkey Finance Ph.D.

    yes sir. Couldn’t have said it better myself. Once you venture into the technical analysis game, all the “bad words” value investors love to make fun of suddenly become relevant–stop loss, SMA, risk management, trading rules, etc.

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