The Downside of Momentum-Based Investing

Sometimes all a story needs is a few pictures. In this case, four charts of stocks that were darlings of the momentum crowd. The point here isn't to issue some sort of mordant chuckle about all this. Instead, it's to note that momentum-based investing can be immensely powerful...until it isn't. At which point the reversals can be truly unforgiving. For example...

click to enlarge

Continental Resources

Massey Energy

Potash Corporation of Saskatchewan

Sandridge Energy

These charts are through yesterday's close. At the moment, late Wednesday morning, three of these four (all but SD) are sharply higher in today's trading. Again, the point isn't to suggest that these are permanently broken stocks. We don't pretend to know that. But think in terms of behavioral finance. When did these stocks look most tempting to professional and rank-and-file investors alike? Two or three months ago? When it looked like they could do no wrong and continue higher more or less indefinitely? 

For the comedic narrative version of this carnage, please read this (via Barry Ritholtz).

Comments

[DaveW:]

Momentum-based success is intoxicating, while momentum-based failure is sobering. Two words: stop-loss. One must actively update the placement of stop-losses......or die a sobering death.

BTW, hilarious article linked at the end.

2008 Aug 13 04:18 PM

[ANTS:]

Kevin, as a holder of a few of these I appreciate your article.

Its a tough world. Had I valued these stocks using normal metrics and listening to broker advice, I would never have bought them. They were always too expensive. But as each day passed, earnings were upgraded and upgraded again until somehow it appeared that the market was the lead indicator and the analysts were just catching up to the true story.

At some point in time, the implied growth rate in the valuation seemed too much, and maybe at that time, the tables turned.

If I have a secret to share, its that I scan the index for these opportunities and I invest in them on a portfolio basis, not as individual picks, nor on the advice of Cramer. So I was lucky (maybe skillful) that my momentum analysis found them early. I must say, I don't know what to do now.

2008 Aug 13 04:24 PM

[KenV:]

I don't know about the rest of the investing world. I knew of Potash years ago. When it split 3 for 1 a year ago I bought in at $70/shr. I have kept this stock but also buy in and out on lows and highs. You just can't listen to all the noise on the street. You have to find a strategy works for you. Buying good companies with good growth.

2008 Aug 13 04:55 PM