Money From Momentum: Positive Feedback Can Drive Returns

by Shelly X. Liang

Positive feedback trading takes into account trends in the stock market. It posits an alternative to theories that advocate buying the market or tracking corporate performance.

According to advocates of technical analysis, it is possible to discern trends and cycles in securities prices that can be traded profitably. The simplest form of this is momentum trading—buying securities with prices that are rising and selling those with prices that are falling. Recent studies find that this can work.

Increasingly, financial economists are uncovering evidence of price trends in various markets. Many markets that appear random are not. Rather, they are complex and hard to predict. The contradictions between experience and accepted theory have led researchers to look for an explanation.

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Shelly X. Liang is a research fellow at the American Institute for Economic Research (AIER).


Discussion

M from Florida posted about 1 year ago:

Momentum Trading and/or Momentum Investing is not a late comer into the Art of common stock Price forecasting. in 1968 while in my last year of MBA studies I became aware of it and since then I have been actively using it as an Intermediate Term Momentum tool, for which I have to thank Mr. Robert A. Levy, Ph.D. who authored "THe Relative Strength Concept of Common Stock Price Forecasting" publ. by Investors Intelligence, 1968. After that I studied the technique of the great Master, the late A.E.R. Coppock and his letter "TRENDEX".
For modern times, it is a must read Professor Grant Henning's book" THE VALUE AND MOMMENBTUM TRADER" pub.by John Wiley & Sons. 2009. It has been amply discussed in Computerized Investing by Wayne Thorp.


M from Florida posted about 1 year ago:

Momentum Trading and/or Momentum Investing is not a late comer into the Art of common stock Price forecasting. in 1968 while in my last year of MBA studies I became aware of it and since then I have been actively using it as an Intermediate Term Momentum tool, for which I have to thank Mr. Robert A. Levy, Ph.D. who authored "THe Relative Strength Concept of Common Stock Price Forecasting" publ. by Investors Intelligence, 1968. After that I studied the technique of the great Master, the late A.E.R. Coppock and his letter "TRENDEX".
For modern times, it is a must read Professor Grant Henning's book" THE VALUE AND MOMMENBTUM TRADER" pub.by John Wiley & Sons. 2009. It has been amply discussed in Computerized Investing by Wayne Thorp.


A from Michigan posted about 1 year ago:

From an Old Investor.
I believe Momentum trading works, but nothing works perfectly all the time. Started trading in 1957 with about $2,000. Trading was hit and miss until about 1968, when with a slide rules started to work out my own technical momentum system to overcome my trading weaknesses. Studied by correspondance under a professional trader in New England, and visited him when he moved to California for a few years in 1969-and early 1970's to learn chart reading, usinf fundamentals and how to trade. In the late 1970's moved my hand system to computers. Was one of the early members of the NY Traders Society, and tried many of their systems, but kept refining and trying to improve my 1970 system, which I now use in a somewhat revised customized fashion at Stock Charts.com. It sure is faster than the slide rule. However, I still do alot of pencil work, because I find just looking at computer outputs, doesn't give one the feel for change that on gets from recording certain data with a pencil or pen in hand.
I've found sign posts in the system that says when to sell and move on, or buy and get in. But, still find that it's hard to do what the system says, like sell a nice winner, or buy an investment early, that has been a loser. Experience in and a feel for the market is very important and should be developed over the years. IBD can help. One needs to determine why one isn't winning in the market and refine a momentum system that helps one to become a winner. Even then systems need refining as the market changes, and that is a constant battle.
Currently handle over 100 investments regularly totaling in the mid eight figures amounts and about 200 trades a year. Consider myself an intermediate trader trying to be a long term investor. Got out of most all equities in 2007 and while my toe got dipped in the water a few times; I didn't really go back into the market with size until March 2009. High volitility bounced my system and me in and out of the market in 2009, 2010, and 2011, but basically have been a buyer since last August 2011, and am trying to hold on, altho a few sales have occured recently. Many bonds and other nice yielding investments have always been held. They keep ones portfolio growing when one is light or out of the market. If momentum is used, one must be persistent, because of the failures that will occur. It only can help ones batting average and no one bats 1,000. Take it from an old ball player-want-a-be and Investor!


Richard from Georgia posted about 1 year ago:

I HAVE USED MOMENTUM INVESTING FOR 50 YEARS. I WAS LUCKY IN THAT ONE OF THE FIRST BOOKS I READ CAUTIONED TO GET COMPLETELY OUT OF STOCKS WHEN THE PPI GETS ABOVE 5%. I ADDED GETTING OUT WHEN THE CURRENT PRICE VS THE 39WMA OF THE SP-500 IS NEGATIVE BASED ON DICK FABIAN'S WORK. THIS IS REALLY A KEY. I GOT OUT OR WENT SHORT SEVERAL TIMES IN THE 60S AND 70S AND BEFORE OCT. 87 AND 2001 AND 2008. ONCE I DETERMINE I NEED TO BE IN THE MARKET I PICK STRONG FUNDEMENTAL STOCKS WITH STRONG EPS AND SALES GROWTH AND CAPITALIZATION BETWEEN $80MM AND $1500MM. THEY MUST ALSO HAVE HIGHER VOLATILITY THAN THE SP-500 AND LEAD IN EITHER THE MARK-UP OR MARKDOWN, AS DESCRIBED BY RICHARD WYCKOFF. I SELL WHEN THE MARK-UP OR MARKDOWN BREAKS THE TREND LINE AND THEN STAY OUT UNTIL THE NEXT BREAKOUT OR BREAKDOWN. I MUST ADMIT THAT I HAVE BEEN MORE SUCCESSFUL BUYING LONG AS OPPOSED TO SHORT.


Alyce from North Carolina posted about 1 year ago:

Any comments from those that are using Vector-Vest's techniques?


David from Iowa posted about 1 year ago:

It would be nice if AAII had a stock strategy backtester. Then discussions could focus around verifiable examples.
AAII could offer the backtester as an add-on to SIPro for an additional cost.
But to the point, my comment is based on backtested data:
Momentum screens backtested, based on various criteria, but having selected stocks sorted on ratios of volume averages, say of 10 day versus 3 month, show promise. Price change is secondary to the volume change supporting it.
The other aspect of selecting by sorting is that the number is not very "deep" per screen. That is, the best results
are of a handful of screens. The backtested returns and the variation to return ratio are impressive. Picking a smaller set of stocks per screen when selecting by momentum makes sense because only the top few would be showing sufficient momentum.
For a backtester, the problem is that the "exit criteria" is the fixed time period selected. Because of this, the more impressive results are of a time period less
than the AAII Strategies (i.e., < 1 month).


Charles from New Mexico posted about 1 year ago:

At the time I started investing in mutual funds in 1990, it was said that all one needed to do was place your money in Fidelity Magellan and come back when you were ready to retire. Then came the transition in fund managers and the new manager promptly made a large bet that went awry. Disgusted with the significant loss, I decided that I needed to make decisions about where to invest, but didn't know any good books to read, so I experimented. I didn't want to do all the background work suggested by most folks about valuing a stock. That seemed way too much work to invest in a mutual fund. Very quickly I fell into momentum investing on my own, but did not know for nearly ten years that it was called momentum investing. Did I bat a thousand? Of course not! It is always possible to buy a fund the day before it begins to fall in price and that eventually teaches one about discerning when to sell. But the system worked well for the next 15 years and my meager investments grew significantly from a few thousand dollars to a high six figure number. Then came 2008 and by that time the mutual fund providers had extended the holding periods for mutual fund selling without incurring a penalty. The combination of volatility and extended holding periods made it impossible to sell mutual funds at the necessary times and the result was a string of losses. I finally got the message that I needed to move on to investing in stocks and ETFs, so that I could sell when needed without being penalized. That change has introduced a new learning curve for me, but I am finally getting a handle on applying my momentum investing experience to the stocks and ETFs. I am optimistic that it can work for me in this new realm of investing.


M from Florida posted about 1 year ago:

Ms. S.X.Liang:
Today I have re read your fascinating essay.and want to comment on the Limitations of Momentum Strategies as you see them. Basically 3: Divergence from Fundamental Values, Increased uncertainty (Risk), and strategies lossing effectiveness on becoming too publicized.

In spite of my academic training in economics,management, finance and statistics, I admit to being a Technical Trend Trader prefering Price Momentum equities and have learned more from practical experience through many years, yet some fundamental values are included in my analysis,which does neutralize some of your stated Limitations, but statistics introduces its own limitations: when we extrapolate into the future with assumed expectations we end up working in a virtual reality due to a % coeficient of error. This is how I handle the limitations.

I no longer Day Trade, do not trade Short and do not leverage. My trade period is 3 weeks to 12 months. Portfolio has no more than 20 equities of equal $ amountss, diversified into several momentum industries. Essential before aBuy order is placed there has to be an exit strategy for each position, as trends don't last forever and may change overnight.

My basic exit is via a Mental Trailing Stop. It is not placed as a Stop Loss Order to avoid the Market Maker from profitting therefrom. At purchase time it is set at 10% below the Price, as Current Price(CP) rises higher than Purchase Price(PP) the Stop Loss is raised thus:

If CP rises 10% over the PP, don't give back to the market >66% of the profit(CP-PP)

If CP rises 20% over the PP, don't give back to the market >50% of the profit(CP-PP)

If CP rises 50% over the PP, don't give back to the market >30% of the profit(CP-PP)

This way you protect your profit without selling too soon nor too late; and the limitations mentioned earlier become irrelevant.If you back test this methodology
you may find that Momentum Strategy is, indeed, profitable.


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