Investing Caffeine

Momentum Investing: Riding the Wave

August 4, 2009 at 4:00 am 8 comments

Riding the Momentum Wave Can Be Dangerous

As famed trader Jesse Livermore (July 26, 1877 — November 28, 1940) stated, “Prices are never too high to begin buying or too low to begin selling.”

For the most part, the momentum trading philosophy dovetails with Livermore’s mantra. The basic premise of momentum investing is to simply buy the outperforming stocks and sell (or short) the underperforming stocks. By following this rudimentary formula, investors can generate outsized returns.  AQR Capital Management and Tobias Moskowitz (consultant), professor at Chicago Booth School of Management, ascribe to this belief too. AQR just recently launched the AQR Momentum Funds:

• AQR Momentum Fund (AMOMX – Domestic Large & Mid Cap)
• AQR Small Cap Momentum Fund (ASMOX – Domestic Small Cap)
• AQR International Momentum Fund (AIMOX – International Large & Mid Cap)

Professor Moskowitz Speaks on Bloomberg  (Thought I looked young?!)

As I write in my book, How I Managed $20,000,000,000.00 by Age 32, I’m a big believer that successful investing requires a healthy mixture of both art and science. Too much of either will create negative outcomes. Modern finance teaches us that any profitable strategy will eventually be arbitraged away, such that any one profitable strategy will eventually stop producing profits.

A perfect example of a good strategy, gone bad is Long Term Capital Management. Robert Merton and Myron Scholes were world renowned Nobel Prize winners who single handedly brought the global financial markets to its knees in 1998 when it lost $500 million in one day and required a $3.6 billion bailout from a consortium of banks. Their mathematical models weren’t necessarily implementing momentum strategies, however this case is a good lesson in showing that even when smart people implement strategies that work for long periods of time, various factors can reverse the trend.

I wish AQR good luck with their quantitative momentum funds, but I hope they have a happier ending than Jesse Livermore. After making multiple fortunes and surviving multiple personal bankruptcies, Mr. Livermore committed suicide in 1940. In the mean time, surf’s up and the popularity of quantitative momentum funds remains alive and well.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

Entry filed under: Financial Markets, Stocks, Trading. Tags: AQR, Bloomberg, Jesse Livermore, Long Term Capital Management, Momentum, Myron Scholes, quantitative, Robert Merton, Tobias Moskowitz, Wade Slome.