SINGAPORE (Feb 12): Buying a stock for no other reason than because it is rising. Holding on for dear life, hoping to exit with a profit before prices come back down to earth. Sounds reckless? Welcome to the world of momentum investing.
Momentum investing goes against the instincts of most investors (“buy low, sell high”) and replaces it with a dare: “buy high, sell higher”. Despite its seemingly counter-intuitive nature, the potential benefits of momentum investing are well established in academic literature, and could help your portfolio perform better than the market average in the long run.
Momentum works on a simple observation: stocks that are rising in price tend to keep on rising, and those that are falling tend to continue in the same direction. Jegadeesh and Titman established this for the US market in their 1993 paper “Returns to Buying Winners and Selling Losers: Implications for Market Efficiency”. In it, they showed that buying stocks that had been rising for three to 12 months, as well as selling stocks falling over the same time horizon, was a profitable trading strategy over the 1965-to-1989 period. Rowenhorst generalised this to European markets from 1980 to 1995 in his 1998 paper, “International Momentum Strategies”, and many other studies have since confirmed that momentum effects do exist in equity markets in general... (Click here to read the full story.)