New research has shown that a more effective way to profit from the momentum effect is to buy the “hottest” factors rather than the best-performing stocks. This according to a Wall Street Journal article by Mark Hulbert, founder of Hulbert Financial Digest.
Researchers found that stocks held in a high-momentum portfolio tend to share the same “factors” and that the “real momentum effect actually takes place at the level of these factors rather than individual stocks.”
“Before this research,” writes Hulbert, “analysts assumed that the only shared characteristic among the stocks owned by the momentum portfolio was that they had beaten most other stocks over the trailing year.” This required the continual sorting of thousands of stocks which the new research shows to be unnecessary. “In fact,” Hulbert writes, “investors will perform just as well, with less risk, by simply betting on the best-performing factors of the trailing year.”
The article explains that the researchers focused on more than a dozen pairs of factors, “with each pair representing the opposite ends of a particular dimension—such as market cap in the case of large-cap versus small.” Other factors observed included quality, liquidity and volatility.