Why it can pay to accept the discomfort of buying stocks hitting new highs

Wednesday, Sep 27 2017 by
31
Why it can pay to accept the discomfort of buying stocks hitting new highs

There are very few stock market signals that catch the attention of investors quite like the 52-week high. Lists of shares making new highs are published in newspapers and on websites around the world every day. But while 52-week high data is easy to get hold of, what does it really tell you and how can you make the most of it?

One of the surprising traits of the 52-week high is that it can have a major impact on the minds of investors - and sometimes that makes it more of a hindrance than a help.

While the information is readily available, evidence shows that it can cause a kind of momentary paralysis in investors that leads to a slow reaction in prices. And when you get the extra kicker of a positive earnings surprise from a stock that’s trading at a 52-week high, this so-called ‘post-earnings announcement drift’ has been shown to be even more extreme. But while all this sounds quite negative, it arguably creates an opportunity for investors who are aware of it.

The lowdown on new highs

I cover the subject of 52-week highs periodically, and it’s one of those areas that provokes a lot of interest. For a start, new highs have the credibility of being used by popular investors like Mark Minervini and William O’Neil. Yet when you look at the research into new highs, the explanation for why they’re important is quite intricate.

Influential research on them was published by Thomas George and Chuan-Yang Hwang in 2004, which found that they were a major driver of momentum. Momentum is the tendency for price trends to persist over the short to medium term, and it’s often linked to how investors think and behave.

George and Hwang reckoned that investors used the 52-week high as a reference point, or anchor. They found that when new-news comes along about a company, it can take days, weeks or even months for the price to shift upwards because of this ‘anchoring’ effect. In essence, existing investors are simply slow to bid the price higher, while onlookers are reluctant to buy at the new high. This is where the term post-earnings announcement drift comes from.

Now this kind of investor irrationality isn’t restricted to 52-week highs. There are other events that cause investors to hesitate that have also been linked to momentum. One…

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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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33 Comments on this Article show/hide all

Graham Ford 27th Sep '17 13 of 33
3

Stockopedia have back tested their formulas that comprise the overall stock rank. Their NAPS portfolio has shown strong returns based on using this ranking system and selecting a diverse group of stocks. So, it is pretty clear that overall this type of strategy works. To say that it has no predictive capability seems rather strange. Momentum has been included because it has a predictive capability.

It is very clear from the performance screen that Momentum rank tracks well with share price performance.

http://www.stockopedia.com/stockranks/performance/?exchanges=LSE%2CISD&field=_MomentumScore_lo∩=10&period=1&buckets=deciles

Stockopedia have provided many write ups and videos discussing how the Stockranks have been used to select the NAPS portfolio and analysing the performance of it. They have checked to make sure they were not just lucky with their selection.

I recommend a review of those videos and reports if there is doubt that this system works.

What people seem to struggle with is that a share with a good Stockrank or good Value rank etc. can then subsequently perform badly. In the universe of high rank shares there will be some that do not perform well but they are outnumbered by those that do.

Stockranks are a way to build a portfolio of a basket of shares not to select an individual share.

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ricky65 27th Sep '17 14 of 33
5

I agree with this article. It's unnatural for most people to buy highs. Most people's natural instinct is to buy weakness, they can't resist a bargain. I think this is a major mistake a lot of people make. I used to be like this but, after reading Minervini's book, I've trained myself to the point where I'm now the opposite - it feels natural for me to buy highs and unnatural to buy weakness. Consequently, my performance improved considerably. Most of my biggest winners have been made from buying breakouts to all time highs.

A good illustration of the phenomenon of people buying weakness is the Hargreaves Lansdown webpage where they show the buy:sell ratios for the top ten most traded shares traded by their clients. You normally see 80-70% buy after a profit warning. Today for example I see 86:14 for Card Factory (LON:CARD) after its 18% drop yesterday on results.

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tradermark1968 27th Sep '17 15 of 33
1

In reply to post #222943

Mark Minervini, Robbie Burns and Bill O'Neil might beg to differ, all multi-millionaire masters of momentum...

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Peter Craven 27th Sep '17 16 of 33

In reply to post #223083

Howard,

I trust you use momentum metrics as a component of you investment decisions?

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Peter Craven 27th Sep '17 17 of 33

In reply to post #223123

tradermark1968,

Would be interesting to learn if the likes of Warren Buffet, Neil Woodford and other fund managers are momentum investors. very unlikely?

In the meantime I'll stick to reading company reports, balance sheets and looking at dividend forecasts and so on.

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clarea 27th Sep '17 18 of 33
3

Any chance of another interview with the momentum master Robbie Burns been about 18 months since the last one.

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ISAallowance 27th Sep '17 19 of 33
2

In reply to post #223168

"In the meantime I'll stick to reading company reports, balance sheets and looking at dividend forecasts and so on."

There's absolutely nothing wrong with that.  Different folk like/suit different styles.  I would much rather buy things cheap as well, and filled my boots with UK financials immediately after Brexit.

However, learning not to be scared of stocks breaking new highs (largely through reading Stockopedia in the last couple of years) has most definitely improved my returns - many of my best returns are firmly in the high flier classification (quality + momentum, not so much value).  Previously my price-anchoring tendencies were most definitely holding me back.

Momentum investors (or at least some of them) read company reports and balance sheets as well.  Taking momentum into consideration isn't simply an excuse to buy any old crap that's going up!  I believe that the evidence suggests that momentum in conjunction with either Q, V or Q+V is an even better indicator of future return than momentum in isolation.

Dividend forecasts - what are you looking for?  If you are looking for a forecast of an increased dividend, I would consider that a momentum indicator.



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Gromley 27th Sep '17 20 of 33
1

In reply to post #223043

Very interesting article, thanks Ed.

I too though have a question about how you identify "earnings surprises".

I can get that this is when published results exceed "market expectations" , but often strong results will have been preceded by a trading update flagging the fact - which will sometimes (dependent on timing, coverage etc.) result in increased market expectations.

If a TU flags over-performance against expectations but the forecast are raised by more than the actual performance, would you analysis miss this as an "earnings surprise" and instead regard it as a "disappointment".

Genuine question as I have found it interesting in the past that the market can sometimes seem to ignore a quite explicit TU but then react positively when the results are published and also the converse.



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Peter Craven 27th Sep '17 21 of 33

I'm an investor not a trader and my volume of transactions is about 6-8 per year. Not enough experience or investigation of momentum trading to have confidence in using this metric.

Companies where dividend forest increases for Year 1 and Year 2 of more that 5% PA are worth looking into.

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Howard Marx 27th Sep '17 22 of 33
6

In reply to post #223168

Peter

There are five proven factors. And there are multiple ways to combine them.

You are correct that Buffett, Woodford (and Greenblatt) favour combining Quality & Value (Q + V) & on the surface de-emphasise Momentum (M).

But plenty of successful investors have centered on Momentum (M), including O'Neil, Driehaus & Minervini.

59cc094f87f9fvenn2.jpg

More than one way to successfully bake a cake!

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pka 27th Sep '17 23 of 33
1

In reply to post #223198

ISAallowance wrote: "I believe that the evidence suggests that momentum in conjunction with either Q, V or Q+V is an even better indicator of future return than momentum in isolation."

Actually the evidence from the UK past performance graphs for Stockopedia's various ranks suggests that the 90-100 Momentum Rank has performed slightly better over he past 4 years than any of the 90-100 QM, VM and QVM ranks:

http://www.stockopedia.com/stockranks/performance/?exchanges=LSE%2CISD&field=_MomentumScore_lo∩=10&period=1&buckets=deciles

http://www.stockopedia.com/stockranks/performance/?exchanges=LSE%2CISD&field=_QMScore_lo∩=10&period=1&buckets=deciles

http://www.stockopedia.com/stockranks/performance/?exchanges=LSE%2CISD&field=_VMScore_lo∩=10&period=1&buckets=deciles

http://www.stockopedia.com/stockranks/performance/

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Howard Marx 27th Sep '17 24 of 33
2

In reply to post #223163

Yes sir.

The factors I prioritise are Quality & Momentum.

Value is the key determinant of long run returns but in the short run is a supporting variable.

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Peter Craven 27th Sep '17 25 of 33
1

In reply to post #223238

Howard,

I was not aware that Buffet, Woodford and Greenblatt use Quality and Value per se. Your post and associated diagram provide a very useful insight.

Cheers,
Peter.

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ISAallowance 27th Sep '17 26 of 33

In reply to post #223243

Hi pka,

Thanks for pointing that out, that's quite a surprising result but certainly for the last few years that appears to be the case.

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rpannell 28th Sep '17 27 of 33

I have been running a few SR portfolios, started every few months. The results at year end have ranged between +6% and +38%. One year ago I started a portfolio, just using momentum as the deciding parameter (buy 10 shares, MR greater than .90, SR.greater than 70. Sell if MR less than 75). Over the past year this has returned 62%.

As someone else said, 1 swallow does not make a summer but on this limited sample the MR portfolio has outperformed all of my SR portfolios. However, as Ben mentioned, it's not easy psychologically to by momentum stocks.

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Redrichmond 28th Sep '17 28 of 33

I use this 52 week high along with p/s and 52 week low. It works..

Minivera in his book suggests using the 52 week low when its over a 100 and 52 week high is 15 or less

I have found tweaking this to also use other metrics but filtering cheap shares (p/s less the 1) and 52 week low 100 or more and spread bps less than 300 bps(thats the part that lose just buying the shares- so if 300bps thats 3 %...the lower bps the better) and 52 week high 5 or less.. also i look at FCF (free cash flow over the last 3 years to see if the cash flow is growing)

From this list I can then filter more on how many screens they relate to and if any of them are the negative red rated screens

A wonderful tool stockopedia is :)

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Ben Hobson 28th Sep '17 30 of 33

In reply to post #222988

Hey Rick,
When I did the screen, financials (specifically funds) were adding lots of noise to the results. So really it was an editorial decision rather than a screening one (but I think it's helpful to show that the rules for these screens can be adapted however you like).
Cheers, Ben

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cig 29th Sep '17 32 of 33

In reply to post #223243

The past 4 years is not a particularly reasonable sampling period, given how benign the market has been.

Also it doesn't work so well in the US, which is a bit worrying, e.g. you could say it's because the US market is saturated with quant investors, which are doomed to go to other markets sooner or later (both existing quants expanding their universe, and local investors adopting the same methods).

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