Are Momentum Based Strategies Still Alive And Well?

by: Jussi Hiltunen

Summary

We all have limited amount of time and capital, and one of the most common questions is 'Where to invest now?'

Momentum based strategies are still alive and well.

Purchasing on 52 week high and selling on 26 week low has historically produced strong alpha.

The investment world is filled with articles regarding different investment strategies. For a regular investor it is usually a very difficult task to know which of the strategies are really viable and suitable for her or him. After all, we all have limited amount of time to devote for studying different strategies. The same can be said about money as due to our limited capital, there is not enough money to diversify to multiple different strategies and then see which one works out. Adding $5000 to one single strategy might not be worth the time and effort.

In this article, I will present one of my own research findings which I did for a very common investment strategy. What I would like to achieve is to show to the readers how this specific strategy has really performed during the last three decades and perhaps make a decision whether this would be a good investment strategy or not. The reason why it is a good behavior to inspect how an investment strategy has performed during multiple bull and bear markets is to see first of all whether that strategy really fits your investment needs and second of all has it really performed at least as well as the major benchmark market indices. Otherwise, investing in plain index fund would be a much better bet.

The strategy which I will show in this article is based on simple momentum performance and the rules are the following:

  • Purchase a stock when it reaches a 52 week high
  • Sell a stock when it reaches a 26 week low
  • A portfolio can contain a maximum of 50 stocks

Using the above rules, I ran a simulation using publicly listed US stocks for the last three decades. The simulation factored in dividends and commissions but taxes were excluded. You can see the simulated results below.

(Source: quantumtester.com)

(Source: quantumtester.com)

The portfolio rose during the simulation period 17.72% annually, when compared to around 10.5% for Dow Jones Industrial Average (NYSEARCA:DIA). (I assumed a 2% dividend yield for the DIA.) The correlation with the benchmark was only 0.55 and the strategy outperformed DIA 65% on a daily basis. On a yearly basis, the strategy outperformed DIA 70% of the time. What is as well very interesting is the way how the strategy performed against DIA during best and worst years during the simulation period. When comparing the best one, three and five year returns against DIA, the strategy always outperformed it. When comparing the worst one, three and five year periods against DIA, the strategy always outperformed it when the period was at least three years.

(Source: quantumtester.com)

Conclusion

Even though the above are merely simulated results, there still exists substantial academic research regarding momentum based strategies. Based on the above strong results, I would consider this strategy a viable candidate as a satellite portfolio next to your core one. If you can sell stocks without incurring capital gains taxes, this strategy would be an even better addition to your portfolio. The reasons for this are that the strategy has performed exceptionally well against DIA in every bull market during the last three decades. Especially the fact that the strategy did not lose any money or lose to DIA over a five year period is a very good point to keep in mind.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.