Academics Wake Up To Momentum

February 20, 2008 at 9:56 am  ·  Category: Business and Investment Philosophy

“Active managers who ignore the momentum effect do so at their peril.”

Paul Marsh, Emeritus Professor of Finance, London Business School, study co-author

“Every object in a state of uniform motion tends to remain in that state of motion unless an external force is applied to it.”

Isaac Newton, Newton’s 1st Law of Motion

“It is a very simple strategy, buying winners and selling losers.  In a well functioning market it ought not to work.  We remain puzzled and we are not the only ones; most academics are vaguely embarrassed about this.”

Paul Marsh, Emeritus Professor of Finance, London Business School, study co-author

A new study by three London Business School professors shows that a strategy of buying the 20 best performers in the previous 12 months, and recalibrating every month, outperforms the overall market while a strategy of buying the 20 worst performers underperforms (Hat tip Michael Covel).

That is: price action i.e. momentum tends to persist unless a counterveling force emerges.

This runs counter to the academic gospel of efficient markets which says that stocks rationally reflect all of the available public information and instead implies that people, to an extent, pile into and out of stocks simply on the basis of the price action.

Anybody who has followed the actual action of stock markets knows that this is true.  It wouldn’t be, I suppose, if humans were perfectly rational machines.  But we’re not.

On this subject also see:

“Dimensional Fund Advisors And The Efficient Market Religion”, Top Gun FP, November 27, 2007

“The Myth of Buy and Hold”, Top Gun FP, November 13, 2007

“A Short Treatise For A Two-Factor World”, James Picerno, The Capital Spectator, May 14, 2007

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