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Salemicus comments on A Guide to Rational Investing - Less Wrong Discussion

26 Post author: ColbyDavis 15 September 2014 02:36AM

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Comment author: Salemicus 15 September 2014 05:23:20PM *  2 points [-]

Re: Momentum:

Firstly, a momentum strategy would have taken huge losses (50%+) in the big stock rebounds of July-Aug 1932, and March-Sep 2009. That certainly supports the view that momentum generates returns only by assuming huge market risk. I can't help notice that your footnote on this point only goes to a paper discussing the value anomaly, not the momentum anomaly. Do you have any thoughts about this?

Secondly, my understanding is that the momentum anomaly has been very small since 2000. See e.g. here. Although you can argue that this "just" reflects the disaster of 2009, it's something that needs to be taken into account.

Comment author: ColbyDavis 15 September 2014 07:50:41PM 4 points [-]

Good point. Again, these strategies don't always work, and their returns are more skewed and leptokurtic than broad market averages, which is probably at least part of the reason they work in the first place. An interesting thing about value and momentum though is that the two strategies have negatively correlated active returns, i.e. value tends to outperform when momentum is underperforming and vice versa, which allows for portfolio construction that can be less volatile than a broad index.

It is true that momentum hasn't been very strong in the US equity market since 2000. It has continued to work among global stocks in general, as well as in other asset classes. Though momentum might just be temporarily out of favor in the US I would generally expect this pattern to continue as the US equity market - and especially blue chip US companies - is the most efficient around. But the global capital markets are a very large place.

Comment author: waveman 25 August 2015 09:20:50AM *  0 points [-]

The paper referred to uses momentum as a cross sectional strategy. The problem with trend following individual stocks within the stock market is the high correlation of all stocks (about 50% of a stock's return is due to the market factor and perhaps another 25% is a sector factor). If you short stocks you are vulnerable to sharp reversals.

I have been using momentum strategies for market timing - ie on the market as a whole not individual stocks - with good success. If you use it to short stocks aggressively you will get very volatile and skewed returns but using momentum of the market as a whole reduces volatility and improves the Sharpe ratio considerably.

Schleifer's paper "The Limits of Arbitrage" http://ms.mcmaster.ca/~grasselli/ShleiferVishny97.pdf gives some insight into why these things aren't arbitraged away. And the EMH is true only to the extend that arbitrage is possible.