Momentum
Process:
Several studies have shown that stocks that have done well in recent months are likely to outperform other stocks over the following several months. Fair Weather Strategies' long term moving average cross-over system exploits this market inefficiency. The strategy tends, in general, to keep the investor holding securities that have high “relative strength” as compared to other securities.
Research:
Jegadeesh and Titman , in their 2001 whitepaper entitled “Momentum”, wrote that “there is substantial evidence that indicates that stocks that perform the best (worst) over a three to 12 month period tend to continue to perform well (poorly) over the subsequent three to 12 months” and that “the best performers appear to be no more risky than the worst performers.”
Tom Hancock, of investment firm Grantham, Mayo, Van Otterloo & Co. outlines in his whitepaper entitled “Momentum – A contrarian case for following the herd” how, from 1927 to 2009, the basket of US stocks formed by taking the best performing quartile of stocks over the prior 12 months, continued to outperform by an annualized rate of more than 3% over the next twelve months.
Past performance is no indicator of future return. There is no guarantee that applying a moving average strategy will either increase your portfolio’s return or lower its volatility as compared to any other strategy. Some securities and market environments are particularly unsuitable for trading using a moving average system. A moving average strategy will likely incur higher commissions than a buy and hold strategy and may or may not increase your taxes relative to buying and holding.