In the simplest terms momentum investing selects stocks that are going up and buys them and stocks that are going down and sells them. There are many different styles of momentum investing. They vary along at least two axis. One is the look back period or how long the stock has to be going up. The other is the holding period or how long you hold the stock before allowing yourself to sell. Another consideration might be the consistency of the up or down move.
I will address two extremes of momentum investing. The first is Day Trading. The essence of Day Trading is that you do not carry overnight positions. All of your buys and your sells happen during the course of one trading day. Before the close, all your positions are sold out and you are in cash over night. Anyone who carries an overnight position may use very similar techniques but is not Day Trading strictly speaking.
Each night, Day Traders examine charts to measure various signs of momentum such as higher highs and higher lows, growing trading volume, passing various Fibonacci retracement levels, and a whole host of others beyond the scope of this post. They decide which stocks to trade the next day. Some trades are entered to trade at the opening price, some look to see if the price action confirms the trend. Day trading works best when there is large volatility in the market or when the overall market is trending higher. The second style of momentum investing I will discuss is long term momentum. One of the enduring mysteries to academics is how this style works in the face of efficient markets. It shouldn't. But, over many decades the effect has persisted. This information is remembered from a presentation by Professor Tobias Moskowitz of the University of Chicago in December of 2005.
In this style, you look backward for some period between six and twelve months. You rank order the investing universe by returns from highest to lowest. In this style, you would take one sixth of your money and buy the top decile and sell the bottom decile. Each month you would do the same thing. At the end of the six months (the start of the seventh) you would include your holdings in the sort and keep the winners that are still in the top 10 percent sell the losers that are in the bottom 10 percent. In December, you sell the portfolio and go to cash, and start up again in February.
This style out performs the S&P500 by significant amounts each year.
You can also use this style of momentum trading for Sector Electronically Traded Funds (ETFs). There are about 30 broad SEC code industries. You would use the same look back and holding period but this time you would buy the top 3 performing funds and sell the bottom 3 worst performing funds. The funds dampen the January effect so you do not need to sell off in December.
I do not have the time nor am I permitted by my employment to Day Trade. But, I am intrigued by the work of Professor Moskowitz and may add this to my ETF strategy.
DRUMMING UP A TRADING TRIBE
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Ask a trader to tell you the hard part of his job. Chances are he'll cite the risk, the uncertainty, the lack of a steady paycheck. Less obvious yet perhaps more moving is the exquisite loneliness.
The source of this loneliness lies far beyond the old cliches about a good trader being a contrarian. A good trader is fiercely honest, uncompromising in his quest to know how markets work, and deeply committed to his own self-development. He feels estranged from a society based on short term political expediency. He cautiously vents a little of his sadness and frustration with an occasional joke about recent political developments. Still, a subtle and deep sense of longing remains. He figures the gnawing at his gut is maybe the feeling of needing more sex, money, or power. When these fail to bring satisfaction, he quietly gives up hope.
Robert Bly, in his book IRON JOHN, captures the spirit of a trend in which men are re-learning how to form tribes and feed each other "blood milk." While some commentators dismiss dressing up in bearskins and beating toy drums as vapid escapism, some of those exercises seem to feed a hungry spot. Aaron Kipnis, in KNIGHTS WITHOUT ARMOR, chronicles the experiences of men meeting regularly over a course of years. As the men learn how to support each other, they give up counterproductive obsessions. Sam Keen, in FIRE IN THE BELLY, echoes and extends the theme. My own personal experience confirms the importance of tribal participation.
I sense a gathering excitment about the possibility of setting up some sort of Trading Tribe along the lines suggested by Bly, Kipnis, Keen and others. Interestingly, the typical men's group comprises men who have no financial interdependence. What if the tribe is also a business? This is pioneering work. We don't have a lot of role models. Nevertheless principles and form seem to emerge as needed.
Consider the politely ignored condition that investors and traders are typically fearful adversaries! The investor threatens to pull the rug out if the trader has a draw down. IBs, Trading Houses, and Money Brokers often institutionalize the tension by keeping investors and traders SAFELY apart.
Offerings typically ignore personal issues and focus almost exclusively on money. And while money, like sex, is certainly an important basis for a relationship, restriction of focus to a single dimension tends to limit how people see and treat each other and tends to brutalize their interactions. Mr. Fatpocket and Mr. Fortypercent see each other as medicine to relieve deep and unacknowledged greed. Mr. Nickel and Mr. Drawdown resent having to put up with each other and hope for better luck next season when the numbers change and they can scramble for new partners. Dollar dimensioned deals memorialize money madness. Fine print specifies commissions, fees, rights and restrictions and seldom requires that parties ever meet in person. The system presses people to get down to business before they get down with each other. Notorious abuse stems from the lack of personal involvement before making deals.
As an alternative, consider a tribe that honors the process of introducing a new member into the Tribal Ethic. The prospect gets a series of invitations to meet members of the Tribe. As chemistry develops, the prospect enters a training program to reinforce the process. He gains deep appreciation for the delicate balances needed to make the total system work. He learns how to give and receive more than just money. Compliance and diligence become important milestones along the path to mastery of ethics and responsibiiity. In time, the new member wins his feathers, by co-creating an inter-dependent organic process that, incidentally, helps him to handle his money.
Securities salesmen typically pitch well-defined products. The Tribe has few such products. The Tribe is more like a clearing community within which investors, traders, brokers, programmers, and other support personnel create and maintain healthy relationships with each other. As such, the salesman has no product to push. He functions to mentor the prospect before, during, and after his initiation.
Occasionally the Tribe sanctions a deal and divvies up the revenue according to the wisdom of the most experienced and most committed Tribal Elders. This Circle of Soul Fathers meets with the Chief from time to time to powwow about such things. The Tribal Divvy and other vitally important decisions are a living, dynamic part of the tribal community.
If you feel your heart beating a little bit faster right about now, you might just be feeling me getting to you out there, sharing a bit of my long-held dream with you, while you respond to my beating of the drum, calling you into the Tribe.
Posted by: Bob Hansell | February 13, 2006 3:14 AM | Permalink to Comment