For a few months now we have been exploring some of the theories and strategies behind momentum investing. For a concept that only started to receive rigorous academic testing in the 1990s, momentum has emerged as a major source of superior returns, with reams of research to back it up, providing intellectual support for those hardened TA investors who’ve always maintained that there’s something in those price charts after all. But while the buy-high-sell-higher phenomenon is now widely acknowledged, the reason why momentum even exists – and why you can take advantage of it – remains less well understood.
When US academics Jegadeesh and Titman revealed to the investing world their backtested theories about momentum in 1993, they acknowledged that the reasons why the phenomenon existed were unclear. Their findings showed that that stocks that perform the best over a three- to 12-month period tend to continue to perform well over the subsequent three to 12 months. To explain this, they only got as far as suggesting that investor expectations are systematically biased and that under-reaction to news about a stock was likely to be playing a role. Since then, investing professionals and academics have gone to town on trying…
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