We’ve been banging the drum for momentum since the turn of the year when it was clear that price ‘triggers’ like positive broker upgrades and earnings surprises were delivering some stellar rises, particularly among small and mid cap stocks. Take a look at the composite performance of all our momentum strategies this year in the chart below and you’ll see a return that’s head and shoulders above anything else - up by more than 40%.

One of the strategies - the 52 Week High Momentum screen - is an interesting barometer of recent price movements. As the name suggests, when it’s rebalanced every quarter it sweeps up shares that are closest to their 52-week high prices. Research has found that these types of stocks will often drift even higher over subsequent months as investors adjust their valuations and bid-up the price through that 52-week ceiling. Of the 25 shares brought into the portfolio in mid-September, all but seven have since risen in price, with seven of the top performers already delivering double-digit percentage gains.

But while buoyant markets have helped to fuel this surge into momentum stocks, there are now nagging questions about how much further some of these shares can go and whether they are too susceptible to a sharp correction if confidence wavers. To tackle this potential problem, it could be worth adding a ‘value’ component to the strategy in order to avoid chasing over-extended shares. James O’Shaughnessy’s research showed that a trending value strategy that combined value and momentum to be “the top stock-market strategy of the past 50 years".

Trending Value

Perhaps unsurprisingly then, the pure play 52-Week High strategy actually lags the so-called Value Momentum screen, which uses the 52-week high and relative price strength as its momentum signals. Importantly though, it also looks for a low price-to-earnings growth factor - or PEG - as a measure of whether a company looks cheap based on its current price, its earnings and its expected rate of growth. Combining value and momentum like this has been shown to be highly effective because when one strategy is working well, the other is often lagging. Bringing them together smooths out returns and reduces volatility.

To look even closer at this combined strategy, we re-worked the Value Momentum screen by adding Stockopedia’s Crossover VM…

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