Momentum Effect

WHAT GOES UP KEEPS going up—or so it seems. Numerous academic papers have documented momentum in stock prices, notably the 1993 paper by Narasimham Jegadeesh and Sheridan Titman  (“Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency,” Journal of Finance, Vol. 48, No. 1). Many quantitatively driven money managers follow a value strategy, but also look for upward price momentum, with a view to buying beaten-down value stocks that are starting to revive.

Researchers have found that stocks with strong short-term performance, typically over 12 months or less, often continue to perform well during the 12 months that followed. What’s behind this share-price momentum? It seems difficult to explain the rewards of momentum investing in terms of increased risk (though that argument has been made).

Instead, it could be that, when good news emerges about a company, investors bid up the share price. But the initial share-price increase doesn’t fully reflect the good news, perhaps because some potential buyers are concerned the improvement may be a flash in the pan. Gradually, investors shed their concerns and purchase the stock, causing the shares to continue climbing.

Intrigued by the momentum effect? Among the funds that seek to exploit it are iShares MSCI USA Momentum Factor ETFSPDR Russell 1000 Momentum Focus ETF and Vanguard U.S. Momentum Factor ETF.

Next: Quality Effect

Previous: Value Effect

Articles: Say No to Mo and Pushing Prices

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