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Many investors swear by the momentum effect as a way of out-performing the stock market. That is, buy a portfolio of shares that have risen the most over the last 3 months, 6 months, or 9 months. Hold them for a few months and then sell them.
A variation on the theme: in addition to the above, go short on a portfolio of shares which have performed the worst over the last 3, 6 or 9 months.
Academics caught onto to this idea about four decades ago and decided to conduct rigorous statistical investigations into whether there really was an interesting market inefficiency in pricing here, or whether some investors were getting carried away with anecdotal evidence about the supposed success of people that use the method.
Much of the evidence showed momentum to work for the periods under study in both the more advanced stock markets and the emerging markets.
Deeper examination showed that momentum is more costly than other strategies – lots of transaction costs – but nevertheless often produced impressive results.
Yet more research questioned the reliability of the technique; did it work in all periods of time? One of my PhD students, Jessie Shi, investigated this and concluded that it worked for UK shares for some long periods of many years, but was reversed in other long periods of years.
Today I want to discuss the evidence on momentum from a US-focused study by Tao Shu published in 2013. Tao Shu’s main interest is whether momentum is only present when a company’s share trading is predominantly in the hands of small investors.
Does it disappear when institutions dominate share trading volume, i.e. does the market get better at pricing shares efficiently when institutions are heavily involved in buying and selling, and therefore there is no opportunity to systematically outperform the market?
(Tao Shu (2013) “Institutional Investor Participation and Stock Market Anomalies (2013), Journal of Business Finance and Accounting, 40 (5) & (6))
Tao Shu’s method
Between 1980 and 2005 the thousands of shares on the NYSE and AMEX were examined each quarter on the basis of the proportion of share trading accounted for by institutions.
They were allocated to one of three groups: Low, Medium, High proportion bought and sold by institutions rather than private investors.
For each month they were also examined on the basis of return over the most recent 6 months. Then they were allocated to one of ten categories (deciles). In category one were the 10% of shares that month with the lowest rate of return the previous 6 months – labelled “losers”. In category two were the 10% with the next lowest 6 monthly return…and so on.
Thus, in any one month a share could be allocated to one of 30 groups based on both its proportion of institutional trading (3 groups) and its return over 6 months (10 groups).
The returns on these 30 groups over the next 6 months were recorded as a percent per month.
The average of these observations over all the months 1980 – 2005 were calculated and presented in the paper.
I’ve converted these results into easy to read graphs……………………………..To read the rest of this article, and more like it, subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
