My biggest insecurity when it comes to my investing comes from the concept of momentum.? For the past 7+ years, I’ve been leaning against the wind, buying companies with bad momentum, and for the most part, it worked.? In general, falling stocks have bounced back.? Over the last six months it has not seemed to work so well.? Now, I had a period that was much worse in the middle of 2002.? I even scraped excess money together to invest in late September of 2002.? I am less confident here.
I have a number of ideas that work with respect to momentum:
- In the short run, momentum persists.
- In the intermediate-term, momentum reverts.
- Sharp moves tend to mean revert, slow moves tend to persist.
My own proprietary oscillator indicates that we are very close to a short-term bounce point.? The recent move down has been too rapid, and sellers should be tired.? One more hard down day, and a bounce should occur.
Back to my own portfolio management.? Since I am a value investor, I have leaned toward longer holding periods, which implies to me that I should be playing for the intermediate-term reversal of momentum phenomenon.? But the short-term momentum anomaly is probably stronger.? Consider these two pieces from Crossing Wall Street.? Eddy illustrates the point well.
So, as I head into my next portfolio reshaping, I am scratching my head, and wondering how I should use momentum in my investing.? Suggestions are welcome.
Perhaps momentum swings both ways; Financials are under enormous pressure for at least the last six months. Shorting a financial ETF using the momentum rules may work out. It would be easily back tested. I don’t have the guts to short positions, but this may provide a strategy for a statistician like yourself to use without emotional involvement. I looked at some of Edde’s stock picks for 2008. I wonder what he believes will drive a change in SYSCO. It has been flat for over six years. IF discretionary spending drops, restaurants will feel the pain, and SYSCO will be a victim. If they had pricing power, why not use it during the past several years to overcome higher fuel and cost of goods? I concur with his observation of Lincare and geriatrics. I live in Florida, and Lincare has a pervasive presence.
Have a prosperous 2008,
Sam
Hello David,
I think you raise a paradox! I think that investing and trying to game momentum are two distinct disciplines. You appear to be very adept at the former, as you are very analytical and experienced analyzing fundamental factors. These skills have little to do with successful use of momentum, in my experience.
I believe that if one looks at successful practitioners of momentum trading like William O’Neil, they all have specific money management techniques to try and limit losses. They also are very aggressive and wiling to buy strength – something that most people have real difficulty doing.
Personally, I believe that the successful path to gaming momentum begins with recognizing that the traditional linear methods of analysis (particularly fundamental but also many technical) are quite useless when trying to assess and predict the evolution of aggregate risk preferences of millions of investors/traders. Complexity theory is where I have turned to try and develop an analytical framework for assessing the collective decision making of investors – like analyzing the activity of bees in a hive!
My advice would be that if you really want to look into adding speculation to your playbook, then you would need to develop your own personal trading style and money/risk management methodology. Reading, re-reading….and then re-reading again the Jack Schwager Market Wizards books is a good place to start in my opinion. There is a ton of valuable insight from people who have successfully developed personal methodologies. The brilliance of the books, in my mind anyway, is that the real success is not in finding a magic bullet but in finding something that suits you personally. The books could stoke some good ideas of what others have done and what may suit you. Good Luck!
“So, as I head into my next portfolio reshaping, I am scratching my head, and wondering how I should use momentum in my investing. Suggestions are welcome.”
I guess the first question is should you use momentum? I mean if you have been successful for numerous years without incorporating momentum, does a 6-month stretch warrant changes?
With regard to “using momentum” I don’t think there is anything contradictory about blending it with fundamental value analysis nor do I think it is necessary to make it ultra-complicated.
My understanding is you are skeptical of technical analysis so I’m somewhat hesistant to mention it, but my own view/method is I simply look for and have a preference to find good fundamental value where the chart looks good in terms of favorable pattern, sideway price action, or an uptrend. I mostly avoid downtrends which is why I am still on the sideline with respect to financials and consumer retail. I prefer to wait for the market to give me some indication a bottom has been put in before jumping in.
Beyond that, a few simple variables like 52-week highs or 6-month relative strength are effective. I know that many value investors spend 100% of their time on the 52-week low list. IMO, there is nothing inherently contradictory about finding value on the 52-week high list. Berkshire spent a large amount of time the past couple of years on the 52-week high list. I know of an individual who has had great success simply combining low valuation parameters with 6-month relative strength and mechanically buying the entire list.
You may want to check out Style Investing by Richard Bernstein. I think his concept of the Earnings Expectation LifeCycle is very useful, and may give some ideas on blending value with momentum. IMO, the good value investor wants to try and buy stocks between 6 and 9, and avoid stocks between 3 and 6 (picture the expectation lifecycle has a clock)
Re: How to use momentum in value-oriented approach to investing?
One category of answer that I’m going to mention for completeness and then say no more about is the large category of people who say one should use valuation for stock selection and technical factors to pick entry and exit points.
Focusing on momentum in particular, I see two other ways for a “valuation oriented” investor to use it. First, it’s rational to believe that other people in the market know more about some companies and industries than you do. It follows more or less directly from that industry and company specific price trends are worth paying attention to when forming expectations of future earnings trends (even if “paying attention to” just means doing more research where the markets view diverges from one’s own). Second, it’s rational to believe that other market participants may be using fundamentally different valuation criteria for equities. In particular, there are a lot of market participants who behave as if the first and second derivative of earnings estimates is a more fundamental valuation criteria than expected DCF. There are also a fraction of market participants (representing a slightly larger fraction of daily trades) who behave as if amount of positive media attention is a primary valuation criteria. These alternative valuation approaches can be modeled, formally or informally, and they can be used either to adjust buy/sell price targets or to adjust portfolio weighting criteria (stocks where these other criteria are in one’s favor could be given large weights and stocks where they are not could be given weights as small as zero).