The Momentum Factor: Why “Buying High” is Safer Than “Buying Low”
The Momentum Factor: Why “Buying High” is Safer Than “Buying Low”
๐ WHO THIS IS FOR
- Target Profile: Active Investors seeking Market-Beating Returns (Alpha) and willing to trade frequently (monthly/quarterly).
- Primary Objective: Trend Harvesting (Capitalizing on the market’s tendency to continue in its current direction).
- Not Suitable For: “Set it and forget it” passive investors or contrarians who psychologically struggle to buy stocks at all-time highs.
EXECUTIVE SUMMARY
- The Myth: “Buy Low, Sell High.” This sounds prudent but often leads to buying “falling knives” (stocks on their way to zero).
- The Reality: Momentum Investing (“Buy High, Sell Higher”) is based on Newton’s First Law: Objects in motion tend to stay in motion. Winners tend to keep winning for 3-12 months.
- The Edge: Eugene Fama, the father of the Efficient Market Hypothesis, called Momentum the “premier market anomaly.” It persists because investors underreact to good news initially, then herd into the trade later.
- Authority Baseline: Research by Jegadeesh & Titman proved that a strategy of buying the past 6-month winners outperforms the market by ~1% per month on average.
Value investors look at the dashboard (Financials). Momentum investors look at the windshield (Price Action). While Value asks “Is this cheap?”, Momentum asks “Is this working?” In a world of algos and information overload, Price is the only truth. According to Team BMT Analysis, combining Momentum with a trend-following filter is the most robust way to capture upside while avoiding the devastating drawdowns of “Hold and Hope.” Source: AQR Capital Management / Gary Antonacci (Dual Momentum)
Scenario: You have $100k to invest. S&P 500 is up 5%. Gold is down 2%. Emerging Markets are up 15%.
- Value Investor: Buys Gold because it’s “beaten down” (Mean Reversion).
Risk: It might keep falling (Value Trap). - Momentum Investor: Buys Emerging Markets because they are the strongest.
Logic: Strength begets strength. Institutional money is flowing there.
Exit Rule: You hold until it drops below its 10-month moving average or is no longer the leader. You have no loyalty to the asset class.
BMT Verdict: Momentum is psychologically hard. You are always buying things that look “expensive.” But the market does not care about your feelings of value. It cares about flows. If you want to maximize geometric returns, you must be in the assets that are actually going up, not the ones you wish would go up.
Factor Performance (1927-2015)
| Investment Factor | Annualized Excess Return (%) |
|---|---|
| Value (Cheap Stocks) | 4.8 |
| Momentum (Winning Stocks) | 9.6 |
*Chart Note: Momentum has historically delivered nearly double the premium of Value. However, it comes with “Momentum Crashes” (sharp reversals), which is why it pairs beautifully with Value in a diversified portfolio. They often move inversely.
The 2008 Test: In 2008, “Buy and Hold” investors lost 37%. Dual Momentum practitioners (who switch to Bonds when Stocks have negative momentum) exited the market in early 2008 because the 12-month trend turned negative. They sat in Treasuries, preserving capital, and re-entered in 2009. Momentum is both an offense and a defense.
โ BOUNDARY CLAUSE: This Structure Breaks Down If:
- Choppy (Sideways) Markets: If the market goes Up 5%, Down 5%, Up 5% every month (Whipsaw), Momentum strategies get slaughtered by false signals and trading costs. Momentum needs a Trend.
- Taxable Accounts: Momentum strategies have high turnover (100-300% per year). In a taxable account, the Short-Term Capital Gains tax will eat your alpha. **Only execute this in an IRA/Roth.**
Execution Protocol
1. Absolute Momentum: Is the S&P 500 above its 12-month return? If Yes, be in stocks. If No, go to Bonds/Cash. (Trend Filter). 2. Relative Momentum: If in stocks, which is stronger? US vs. International. Buy the winner.
MTUM (iShares Momentum): Large cap, rebalances semi-annually. Good but slow. QMOM (Alpha Architect): Highly concentrated, quantitative momentum. More aggressive. SPMO (S&P 500 Momentum): Low cost, captures the factor effectively.
Momentum decays fast. You cannot hold a momentum stock for 5 years blindly. NVIDIA might be a momentum stock today and a value trap tomorrow. You must refresh the portfolio regularly.
This is an “Active Beta” strategy. It requires adherence to rules even when they seem wrong. The hardest trade to make (buying the all-time high) is usually the right one.
WEALTH STRATEGY DIRECTIVE
- Do This: Allocate 10-20% of your portfolio to a pure Momentum fund (like QMOM) to capture the “Right Tail” explosions during bull markets.
- Avoid This: Chasing performance without a system. Buying a stock after it has gone up 300% in a week is not Momentum investing; it is FOMO. Momentum targets the “sweet spot” of the trend (3-12 months), not the exhaustion phase.
Frequently Asked Questions
Is this just chasing bubbles?
Sort of. Soros famously said, “When I see a bubble, I buy it.” Momentum investors ride bubbles up but have strict exit rules (Trend Following) to get out before the crash wipes them out.
Why does it work?
Behavioral finance. Investors anchor to old prices and sell winners too early (Disposition Effect), slowing the price rise. Momentum strategies capture the rest of the move as the market slowly catches up to reality.
Does it work in Bear Markets?
Standard Momentum (“Long Only”) crashes in bear markets because the “winners” are just the stocks falling the least. “Dual Momentum” (Trend Following) avoids this by switching to Cash/Bonds when the absolute trend is negative.