Quantitative Momentum

A Practitioner's Guide to Building a Momentum-Based Stock Selection System

Wesley R. Gray, Jack R. Vogel

• Publisher: Wiley
• Year: 2016
• Print ISBN:
  9781394377930
  9781119237198
• Edition: 1
• eBook ISBN:
  9781119237259
• Topic: Business
• Subtopic: Finance
• Index: Business

The individual investor's comprehensive guide to momentum investing

Quantitative Momentum brings momentum investing out of Wall Street and into the hands of individual investors. In his last book, Quantitative Value, author Wes Gray brought systematic value strategy from the hedge funds to the masses; in this book, he does the same for momentum investing, the system that has been shown to beat the market and regularly enriches the coffers of Wall Street's most sophisticated investors. First, you'll learn what momentum investing is not: it's not 'growth' investing, nor is it an esoteric academic concept. You may have seen it used for asset allocation, but this book details the ways in which momentum stands on its own as a stock selection strategy, and gives you the expert insight you need to make it work for you. You'll dig into its behavioral psychology roots, and discover the key tactics that are bringing both institutional and individual investors flocking into the momentum fold.

Systematic investment strategies always seem to look good on paper, but many fall down in practice. Momentum investing is one of the few systematic strategies with legs, withstanding the test of time and the rigor of academic investigation. This book provides invaluable guidance on constructing your own momentum strategy from the ground up.

• Learn what momentum is and is not
• Discover how momentum can beat the market
• Take momentum beyond asset allocation into stock selection
• Access the tools that ease DIY implementation

The large Wall Street hedge funds tend to portray themselves as the sophisticated elite, but momentum investing allows you to 'borrow' one of their top strategies to enrich your own portfolio. Quantitative Momentum is the individual investor's guide to boosting market success with a robust momentum strategy.

Part One

Understanding Momentum

This book is organized into two parts. Part One sets out the rationale for using momentum as a systematic stock selection tool. In Chapter 1, “Less Religion; More Reason,” we provide a discussion of the two dominant investment religions: fundamental and technical. We propose that evidence-based investors consider both approaches. Next, in Chapter 2, “Why Can Active Investment Strategies Work?” we outline our sustainable active investing framework, which helps us identify why a strategy will work over the long haul (i.e., the “edge”). In Chapter 3, “Momentum Investing is Not Growth Investing,” we propose that momentum investing, like value investing, is arguably a sustainable anomaly. Finally, we end Part One with Chapter 4, “Why All Value Investors Need Momentum,” a discussion of the evidence related to momentum investing, which suggests that most investors should at least consider momentum investing when constructing their diversified investment portfolio.

CHAPTER 1
Less Religion; More Reason

Child: “Dad, are you sure Santa brought the presents?”

Father: “Yes, Santa carried them on his sleigh.”

Child: “I guess that makes sense. He did eat the cookies and milk we left by the fireplace.”

—Typical adult/child chat on Christmas Day

TECHNICAL ANALYSIS: THE MARKET'S OLDEST RELIGION

During the 1600s, the Dutch had a large merchant fleet and the port city of Amsterdam was a dominant commercial hub for trade from around the world. Based on the growing influence of the Dutch Republic, in 1602 the Dutch East India Company was founded, and its evolution into the first publicly traded global corporation drove a number of financial innovations to the Amsterdam Stock Exchange, including the subsequent listing of additional companies and even short selling.

In 1688, Joseph de la Vega, a successful Dutch merchant, wrote Confusion De Confusiones, one of the earliest known books to describe a stock exchange and stock trading. Some researchers today argue that he should be considered the father of behavioral finance. De la Vega vividly described excessive trading, overreaction, underreaction, and the disposition effect well before they were documented by modern finance journals.¹

In his book, de la Vega describes the day-to-day business of the Exchange and alludes to how prices are set:

---

When a bull enters such a coffee-house during the Exchange hours, he is asked the price of the shares by the people present. He adds one to two per cent to the price of the day and he produces a notebook in which he pretends to put down orders. The desire to buy shares increases; and this enhances also the apprehension that there may be a further rise (for on this point we are all alike: when the prices rise, we think that they fly up high and, when they have risen high, that they will run away from us).²

---

De la Vega seems to be describing how rising prices themselves can beget continued price increases. Put another way, in the words of Wes's graduate school roommate who managed a market making desk at a large Wall Street bank, “High prices attract buyers, low prices attract sellers.”³

De la Vega continues:

---

The fall of prices need not have a limit, and there are also unlimited possibilities for the rise…Therefore the excessively high values need not alarm you…there will always be buyers who will free you from anxiety…the bulls are optimistic with joy over the state of business affairs, which is steadily favorable to them; and their attitude is so full of [unthinking] confidence that even less favorable news does not impress them and causes no anxiety…[It seems] incompatible with philosophy that bears should sell after the reason for their sales has ceased to exist, since the philosophers teach that when the cause ceases, the effect ceases also. But if the bears obstinately go on selling, there is an effect even after the cause had disappeared.⁴

---

Here de la Vega explicitly discusses how bulls can continue buying, and bears can continue selling, even when there is no direct reason or cause for them to do so, other than the price action itself. So here we see how, even in seventeenth-century Europe, price changes—independent of fundamentals—can affect future market prices.

While early technical analysis was evolving in stock trading in Europe, an even more fascinating financial experiment was taking place in Japan. During the 1600s, the peasant class, who made up the majority of the Japanese population, was forced into farming, thus supplying a tax base that could su...

Table of contents

• Cover
• Title Page
• Copyright
• Table of Contents
• Dedication
• Preface
• Acknowledgments
• About the Authors
• Part One: Understanding Momentum
• Part Two: Building a Momentum-Based Stock Selection Model
• Appendix A. Investigating Alternative Momentum Concepts
• Appendix B: Performance Statistics Definitions
• About the Companion Website
• Index
• End User License Agreement