Momentum – A Powerful Anomaly


One of the most powerful trends in the stock market over the short-term is something called momentum. This essentially means that stock prices that move up tend to keep moving up, whereas those that move down tend to keep moving down. It has been found to be more extreme for relatively larger moves. So for example, if a stock sees a big move up relative to other investments in the market, that move is more likely to continue, whereas if the move is relatively small, then it has less predictive power.

The effect has been documented for some time, but Jegadeesh and Titman did some detailed research in 1993. They find that a strategy of buying winners and selling losers in terms of past stock performance can outperform the market by 10% a year, on average. However, one risk with momentum investing is that it tends to perform less well around market crashes. This means that it may not offer support for your portfolio when you most need it. However, it can support long-term performance if history is any guide.

Subsequently, in their paper Value and Momentum Everywhere, Cliff Asness and fellow researchers found that the momentum effect found in the stock market can also be seen in other financial markets over time.

The reason for momentum may be linked to something called the disposition effect. This is the tendency of investors to want to sell their winning investment and hold onto their losers. If they are doing this regardless of changes stock fundamentals then this behavior could lead to the momentum observed in the financial markets.