UK stock market indexes have broken out in recent months, but with a number of shares hitting new 52-week highs, investors face some difficult questions. On one hand, our innate aversion to losses makes it seem sensible to take profits on winners. But on the other, there’s evidence that these high flyers can go on to fly much higher. With that in mind, it’s worth exploring this uncertainty and how to get more comfortable with strong momentum.
In the financial press, the 52-week high is one of the most commonly quoted facts about a share. It’s a key momentum signal that points to the most popular stocks in the market. Yet, the very idea that a stock is streaking ahead can be enough to cause uncertainty. This is exactly what we’re seeing with stellar risers like Boohoo.com right now.
Why the 52-week high is confusing
Part of the reason why the 52-week high is contentious is that it’s a positive signal that actually causes investors to consider selling. On paper this seems crazy, but research shows that investors are predisposed to selling winners and holding losers, and the 52-week high exacerbates it.
In 2015, a study by Jason Birru looked at this in detail and found that the 52-week high creates a psychological barrier in the minds of investors. He found that both investors and analysts simply stopped believing the stock would rise further, and they became less objective and under-reacted to news about it. Ultimately, they became more inclined to sell it.
Birru’s work echoed the findings of other studies into the drivers of momentum. The common thread between them is that uncertainty in the minds of investors leads them to underreact to good news about high momentum stocks, which actually causes their prices to drift higher over time. Far from selling these stocks, there’s actually an argument for buying them - which is why so many hedge funds swear by momentum.
Yet, as a factor on its own, momentum it’s prone to vicious reversals, so it’s no surprise that it provokes fear. When investor sentiment is pushing prices higher, any change in mood can be sudden and severe.
Taking a multi-factor approach
To combat this risk - whether it’s a current holding or a possible purchase - it’s worth exploring whether the momentum is supported by another driver of returns, such as company quality. This combination of factors is a hallmark…
