One observation I regularly share is the constant flow of research papers and books about topics I am interested in. Specifically, these topics are listed on the “About” page, but they are primarily those with the potential to create positive asymmetry in the P/L (that is: more profit than loss). The “momentum” subject is a big one for me, since I have operated directional trend systems for more than a decade. Momentum is sometimes called relative strength, or inertia, or trend-following. There are now more than 300 papers I know of documenting evidenced of momentum: whatever trend has been within the last year tends to continue. It’s interesting reading these research papers. They are sometimes written by academics at a University and sometimes by research at an investment company. The funny thing is they are rarely written by an investment manager who has strong performance history actually doing what they write about. I wouldn’t dare write a paper specifically about what I do that works. Nevertheless, these researchers share their opinions and only a few of us know how correct or wrong they may be. You see, a research paper is just a study or opinion, we can never really prove something true since it can some day be proven untrue. Think: swans are white, until you see a black one. As I see it, the only people qualified to say so is if they themselves have good actual performance history doing these things. Experience matters, but research isn’t so much about experience as it is thinking deeply about a subject and offering ones views and findings.
I just got in my inbox a new paper by Ryan Larson Hot Potato: Momentum As An Investment Strategy (August 2013).
So what are investors to do with momentum? Our conclusion is that momentum is inadvisable as a stand-alone strategy due to the risk of precipitous losses. Rather, we suggest that long-term investors seeking to tap more than one source of equity premium choose another, more stable factor for their core investment strategy (value is certainly a strong candidate), and consider adding momentum as a short-term trading strategy when market conditions are favorable.
I agree that momentum (or relative strength) by isn’t best used as a stand alone strategy, but adding some other strategy like “value” to it isn’t the answer. Momentum (or relative strength) needs active risk management.