A 🧵🧵 on Momentum Investing. In this thread I will explain
1. What is Momentum Investing?
2. What Causes Momentum Effect?
3. How can it be implemented?
4. Backtesting results to show evidence of periods when it worked and didn't.
5. Drawbacks of Momentum investing.
1. What is Momentum Investing?
2. What Causes Momentum Effect?
3. How can it be implemented?
4. Backtesting results to show evidence of periods when it worked and didn't.
5. Drawbacks of Momentum investing.
1. Momentum Investing is a strategy where investors buy rising shares and sell them when they look to have peaked
The goal is to take advantage of volatility, buy high and sell higher instead of the conventional wisdom of buy low, sell high.
The goal is to take advantage of volatility, buy high and sell higher instead of the conventional wisdom of buy low, sell high.
Such investors hope the upward trajectory of the stock will continue for some time and seek to take advantage of it
Stocks that have outperformed are expected to continue their outperformance & stocks that have underperformed are expected to underperform even further
Stocks that have outperformed are expected to continue their outperformance & stocks that have underperformed are expected to underperform even further
high higher, low lower is the crux of Momentum investing
2. Momentum Effect is caused by
a/Overreaction of the market in both outperformance and underperformance
b/Conservatism Bias - Investors react slowly to new information, and this causes delay in a trend to reverse
2. Momentum Effect is caused by
a/Overreaction of the market in both outperformance and underperformance
b/Conservatism Bias - Investors react slowly to new information, and this causes delay in a trend to reverse
Price Momentum investing is one of the factors which can be used in factor investing
Others are
SMB(small minus big)
HML(high minus low)
RMRF(equity index minus t-bill)
WML(winners minus losers) Return on PTF of past year's winners minus return on PTF of past year's losers
Others are
SMB(small minus big)
HML(high minus low)
RMRF(equity index minus t-bill)
WML(winners minus losers) Return on PTF of past year's winners minus return on PTF of past year's losers
3. A simple way to implement Momentum strategy can be to buy the best performing stocks over the last 6 months and short the worst performing stocks over the last 6 months
The strategy can also be implemented by only buying the best performing stocks part (positive momentum)
The strategy can also be implemented by only buying the best performing stocks part (positive momentum)
4. ET Money did a research by selecting the top 10 stocks with highest price rise in past 6 months over 4 periods
They then hold the stocks for next 6 months period
Pic shows that upward momentum stocks returned 1%, 6%, 16% and 36% over the next 6 months period
They then hold the stocks for next 6 months period
Pic shows that upward momentum stocks returned 1%, 6%, 16% and 36% over the next 6 months period
A point to note is Momentum strategy has been found to work well in Normal market conditions
However this strategy has been found to be faltering in conditions of extreme market volatility such as COVID 2020-21
Pic shows underperformance of Momentum strategy during 2020-21
However this strategy has been found to be faltering in conditions of extreme market volatility such as COVID 2020-21
Pic shows underperformance of Momentum strategy during 2020-21
5. Two likely drawbacks of Momentum Strategy are
A/ Higher volatility in returns compared to the Market cap index
B/ Higher transaction cost due to the churning of the Portfolio at regular intervals
A/ Higher volatility in returns compared to the Market cap index
B/ Higher transaction cost due to the churning of the Portfolio at regular intervals
ET Money research on the performance of Nifty 200 Momentum 30 TRI index shows that this index has outperformed other major indices from 2011 to 2020
However there has also been evidence of underperformance during periods of extreme market movements
However there has also been evidence of underperformance during periods of extreme market movements
UTI Nifty 200 Momentum 30 Index Fund is a passive index fund which can be used to try the momentum strategy without getting into the complexity of doing it on own
However it is best to be cautious and use this if you are okay with high volatility and cost
However it is best to be cautious and use this if you are okay with high volatility and cost
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