Thursday, May 5, 2011

Good Observation about Momentum Strategies

There are so many trend following and momentum strategies out there that when the fire alarm is rung they cannot all fit out the door at the same time. That is why we have seen a 30% crash in silver and and a severe declines in other commodities.
I don't think a momentum "investing" strategy works over an entire market cycle.


Taylor Conant said...

Momentum is intellectually lazy and not a strategy in the same way that seeing people queuing outside a building and deciding to join the end of the line to see what happens is not a strategy.

It's also a logical fallacy, "Argument from Authority", with the authority being the crowd and the argument being whatever they happen to be throwing their money at.

How many REAL business people form businesses to chase momentum? No, I am not talking about chasing the profits that one believes are available for serving a popular consumer demand, I am talking about chasing the momentum purely of what most other entrepreneurs are perceived to be doing. Are yogurt shops opening all over town? Then you'll open a yogurt shop! (And so will all the potential yogurt consumers.) Are entrepreneurs buying up land and drilling for oil? Then get prospecting! (Etc.)

What happens, each and every time? Glut of supply, dearth of demand. Margins are crushed, profit collapses and the momentum chaser is found expired, facedown in a gutter after being stampeded by everyone attempting to flee the soon-to-be ghosttown.

Besides, do you even know how to make and sell yogurt, or drill for and market oil? Nevermind...

CP said...

Check out these relative strength aficionados:

They were really noisy at the beginning of the year - the high water mark for the momentum strategy - and referred to value investing as a "cult".

[Although, there is actually a human built-in cognitive heuristic to copy other people's decisions on the basis that they probably know more than you do.]

Taylor Conant said...

This is a great example of one of the many flaws of "empiricism" and obsession with academic studies of historical data: you can completely miss the common sense and convince yourself the logically self-contradictory is nonetheless intellectually valid and sustainable.

Case in point--

The value "cult" proposes buying $1 of value for less than $1. If you are in fact buying $1 of value, you have made a successful investment in the moment of buying.

The momentum "school" proposes buying $1 of value for more than $1, and then selling that $1 of value for >$1+n to someone else. Your expected profit isn't "locked in" in the buying like it is for the value investor but rather is hoped for in the selling, a proposition which is decidedly more uncertain because you've given yourself no room for error from the get-go by purposefully paying more for something than it's actually worth.