Behavioral finance FAQ / Glossary (Momentum)

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This is a separate page of the M section of the Glossary

 

Dates of related message(s) in the
Behavioral-Finance group (*):

Year/month, d: developed / discussed,
i: incidental

images/images/pi-arrig.gif Momentum

images/images/pi-arrig.gif Momentum effect

Momentum investing /
    trader / trading

00/8i - 01/1i,3i,4i - 02/5i,8i,
10i,11i - 03/1i,5i,6i - 04/2i

+ see effect, cycles, trend
following, overreaction + bfdef3


Following the fastest horse.

To the pasture? Or to the cliff?

Definition (momentum):

In an asset market, a price momentum is the direction and speed

of an upward or downward price trend (see trend)

Definition (momentum effect):

The momentum effect is a quite usual market phenomenon by which
asset prices follow a trend for a rather long time.

This can mirror economic evolutions, but in some cases it brings a
growing discrepancy
between prices and "fundamental" values (see
effect, overreaction, trend, bandwagon...) ...until reality strikes back.

How far is too far?

Definition (momentum trading):

Momentum trading is the application of strategies based on

"trend following" (see that phrase):

Buying what goes up, selling what goes down.

This "follower" practice is rather common in short or medium term money
management.

A preferred playground of "medium term" momentum traders
are assets in which a strong price momentum has started and
lasted for a long enough number of months
.

Typically, those players would preferably:

Buy stocks that gave the highest return
    in the
  previous year.


Sell those that gave negative returns.

Is it a bias? For how long it is sustainable?

Riding the horse until jumping off

This "follower" thinking can be seen as a mental bias, often linked to short
memory and rational expectations.

On the other hand, trend spotting might (sometimes) offer

opportunities.

A rule of thumb among trend followers is that a trend that reached an

optimum time and strength (at least one year
and a 20% rise or fall)
to settle in has above average chance to
self replicate in the next period (another year).

This can be linked to underreaction followed by adjustment and
     later
an overreaction, as a social learning curve (see trend).

But to follow that strategy for too long, let us say over three

years,might be looking for trouble, ask any contrarian (see that
word). The momentum might break without warning

The opposite bias is the "gambler's fallacy"

(the belief that there will be automatically a reaction in the other direction).

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This page last update: 11/09/15  

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