Money From Momentum: Positive Feedback Can Drive Returns
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.
In this article
- Reacting to Momentum Is Rational
- Random Prices and Divergence From Fundamental Factors
- Are Profits From Price Momentum Possible?
- Limitations of Momentum Strategies
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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.
Reacting to Momentum Is Rational
The positive feedback trading hypothesisis gaining increasing support among researchers as an explanation for momentum in securities markets. The idea is that at times traders may buy a security simply because it is going up in price. If a large number of traders buy the security, their combined buying pressure drives the price even higher, inducing even more traders to buy.
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