Fast-moving stocks that are riding a momentum wave

Tuesday, Jul 17 2018 by
41
Fastmoving stocks that are riding a momentum wave

Momentum strategies have delivered some of the strongest returns from equity markets over the past few years - certainly in the UK and Europe. In these kinds of bullish conditions, models that zero-in on 52-week highs, earnings forecast upgrades and earnings surprises have produced impressive results. An even more straightforward momentum strategy is to just look for stocks with the strongest price momentum in the market. It sounds simple, but it’s a strategy that’s proved to be consistently profitable.

As a reminder, momentum strategies are based on the idea that price trends persist - both up and down. It’s a powerful driver of stock market profits, which is why we model several momentum strategies at Stockopedia. It’s also why the MomentumRank is a key component of Stockopedia’s StockRank. A couple of months back I wrote about some of the behavioural ‘drivers’ that can make these strategies so effective.

One of the original Price Momentum strategies was actually a test devised by researchers Narasimhan Jegadeesh and Sheridan Titman. They were two of the very earliest academics to tackle the concept of momentum and their landmark studies used very straightforward techniques that still work well today.

The strategy focuses solely on a stock’s price strength relative to the rest of the market. Jegadeesh and Titman found that momentum often lagged for the first month after new news was issued about a stock. But then it accelerated over the subsequent three to 12 months.

In their paper they wrote: “The strategy we examine in most detail, which selects stocks based on their past 6-month returns and holds them for 6 months, realises a compounded excess return of 12.01% per year on average.”

This strategy is one of several momentum screens tracked by Stockopedia, and we’ve generally seen consistently robust returns from it over the past six years - with a 38.8 percent gain seen over the past 12 months alone. (Remember that those returns are based on quarterly rebalancing and ex-costs).

5b4ddc6550e8dPrice_Momentum.png

One problem with momentum - and one of the reasons some believe it exists at all - is that it collapses farthest and fastest when confidence dries up. You only need look at how the momentum trade crashed during the financial crisis 10 years ago to see the damage that can unfold.

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Disclaimer:  

As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested. ?>


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11 Comments on this Article show/hide all

Wimbledonsprinter 17th Jul '18 1 of 11
3

“Only when the tide goes out do you discover who has been swimming naked.” I guess the quality and value filters, Ensure the swimmer is not completely starkers. Personally, I am frightened by the current valuation of most of the momentum stocks and can’t invest in them and sleep soundly. But I would have said the same 12 months ago.

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Zoiberg 17th Jul '18 2 of 11

Am I missing the point? Every single one of these stocks has a negative one month relative strength.
To quote from the text above "If those companies slow down or if sentiment changes towards them, their share prices can crash."

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Gromley 17th Jul '18 3 of 11
2

In reply to post #382889

Am I missing the point? Every single one of these stocks has a negative one month relative strength.
To quote from the text above "If those companies slow down or if sentiment changes towards them, their share prices can crash."


I don't think that you are missing the point at all Zoiberg, but I think that there may be something that Ben has not explained.


The filter includes the term RS 1m < 0 (corrected thanks to rpannell) which explains the results you observe, but  Ben didn't elaborate on that. I have read that momentum is in fact a negative factor in the "short term" (whatever that means), so perhaps that is the reason.

Effectively I see this as buying momentum stocks when they are "taking a breather" in their stratospheric rise, I have certainly read subjective discussions on that idea, but it would be great if Ben could confirm  the rationale for this filter.

 


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rpannell 17th Jul '18 4 of 11
1

Actually, it's RS 1m < 0 but everything else that Gromley says is correct

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Gromley 17th Jul '18 5 of 11

Thanks rpannell - I've corrected that now - I chose the wrong chevron!! Hopefully it makes more sense now!

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sh62@gmail.comG 17th Jul '18 6 of 11

In reply to post #382914

Hi Zoiberg / Gromley -

I was scratching my head about all the red ink under the RS 1m column header - did this mean that we have now come to a turning point when momentum works against us - for all those shares listed ?

Would be interested to hear from Ben why he included the RS 1m < 0 filter - the taking a breather in an otherwise steep rise makes sense (p.s. Gormley & sorry to mention this - you did mean the filter include RS 1m < 0 presumably ?)

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Richard Cook 17th Jul '18 7 of 11

Buying on the dip is not for me. Sometimes the dip is a cliff.

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BH1991 18th Jul '18 8 of 11
5

In his study of price momentum, Jegadeesh states "there exists a reversal or contrarian effect in returns which may be related to liquidity or microstructure issues" when referring to momentum in the short term (e.g. 1 month or less).

Now you're probably thinking, what on earth does this mean?!

My interpretation of this, is that the shorter the time frame, the more likely you are seeing "noise" rather than true momentum. This "noise" is not predictive of future returns.

In the short term, investors may face liquidity issues where they are unable to acquire full positions in stocks due to the lack of available shares. Therefore, investors will 'pyramid' into positions over the medium/long term, thus creating momentum.

Secondly, "microstructure issues" is the notion that information is not interpreted equally amongst all market participants. In the short term, investors will reach different conclusions at different times when assessing a new piece of information. However, in the medium/long term, most investors will reach a general conclusion on the stocks direction, thus creating momentum.

In most momentum studies, the last month is usually excluded from their analysis because of the "noise" effect. However, placing RS 1m < 0 isn't a bad workaround in my opinion because it allows the investor to buy the pull back in a share which is trending upwards. 

It's widely known amongst momentum traders to focus on the "bigger picture". Chasing short term, parabolic moves is what gets most traders into a lot of trouble. Ignore the short term movements and always focus on the medium/long run trend (whether that's fundamental or technical).

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pka 18th Jul '18 9 of 11

In reply to post #382944

'In most momentum studies, the last month is usually excluded from their analysis because of the "noise" effect. However, placing RS 1m < 0 isn't a bad workaround in my opinion because it allows the investor to buy the pull back in a share which is trending upwards.'

in my opinion, including the RS 1m < 0 filter merely excludes from consideration about half the universe of stocks with high price momentum without properly replicating what Jegadeesh and Titman did in their studies. I guess that this particular Stockopedia screen would have performed significantly better if the RS 1m < 0 filter had not been included. In particular, this filter seems to me to be encouraging the opposite of what a stop-loss rule would do (which is to sell any stock in one's portfolio that suffers a sharp price drop greater than some threshold), and many momentum traders are strong advocates of stop-loss rules.

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Lawman 18th Jul '18 10 of 11
1

Indeed there is a risk that high Momentum stocks can fall hard. The remedy is to be disciplined with trailing Stop Losses.

RS<0. I make no comment on the validity, but it could demonstrate that the Price has paused while some sellers are shaken out, to be followed by lack of "overhead supply" resulting in the Price moving up.

Classic Minervini theory.

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iwright7 19th Jul '18 11 of 11
2

Ben, You rightly point out that a pure Momentum strategy can be dangerous in a market downturn and that many investors introduce Quality (or QM) criteria to soften this risk.

I have only recently become aware of the q-Factor Model mentioned in Digesting anomalies: an investment approach  which suggests that the ROE profitability Factor in their q-Model has a causal link with the Momentum. If this is true then for long term maximal returns it becomes even more important to combine Momentum with ROE/Quality. This idea confirms my own bias, but do others have a view? Ian

Background....

Digesting anomalies: an investment approach    https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2508322

The 52-week high, q theory and the cross-section of stock returns  https://papers.ssrn.com/sol3/p...

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