Market Hypothesis: Does Momentum Exist In US Markets?

---

How to Read This Article

All research projects at GVR are meant to be digestible by both beginners and advanced readers. In order to achieve this, no definition is given in the text body itself. Instead, all concepts and words that I believe need explaining are bolded, italicized, and subscripted[1]. At the bottom, there is a definition and concepts page. I recommend having this open on two tabs. One will be for the reading portion, and the other with the definitions open so you can quickly pan back and forth without having to scroll annoyingly.

---

This is a "hypothesis" article. My goal is to structure it like an experiment. The article will be organized in the following way, with the following possible sections:

Article Structure

1. Hypothesis: 

   1. All of my testing starts with a question. Some come from observation, and others from reading white papers (if there were black/brown papers I would read those too, calm down) and academic publications. I'll start the email with the question I hope to answer

2. Testing Methodology: 

   1. How are we going to define the question and test it?

3. Results:

   1. What have we found? Did we confirm or deny others research? 

4. Discussion:

   1. Explain the results and any interesting insights

5. Economic Concepts:

   1. What are some economic concepts that would be important to understand when testing this theory? What explanations do economists give?

6. Math / Stats Concepts: 

   1. In testing this idea, what concepts from math and stats can we incorporate to ensure the integrity and validity of the test?

7. Coding Concept:
   

   1. What interesting techniques can we employ to test it faster, better, more efficiently, etc.

8. Financial Markets Concept:

   1. There are some ideas that have more to do with financial markets nuance than overarching economic principles. If they apply to our situation, what are they and how are we taking advantage of them?

9. Trading Concept:

   1. Just like the Financial Markets and Economics Concepts, there are some ideas that are purely short term in nature, and have more to do with market microstructure and timing than sound economic and financial concepts. Although largely a big bag of lies, there are things that can be gleaned from those concepts. If any apply, they will be here.
      

10. Further Testing: 

    1. Did this hypothesis spark more ideas? How can we change our current test or definitions to test slightly different phenomena? Can we break down the idea further to better understand the game we are playing?

11. Reference Papers:

    1. Links to the publications and media you can go to to learn more about any of the mentioned concepts. 

12. Definitions:

    1. Part of my hope is that anyone can read these no matter your familiarity with stupid financial lingo. Half the battle of being able to effectively read market publications is understanding the absurd language they speak. I'm hoping to write these emails as 'financy' as possible, but put definitions in the bottom so that anyone can begin to get comfortable with terminology that they will see outside of these

---

1. Hypothesis/Question

   1. Does momentum[1] exist in US Equities[2].

2. Testing Methodology

   1. Run each US equity through time, and enter into a long[3] position when passing above the 52 week high. Equally, enter a short[4] position when passing below the 52 week low.  The holding period[5] most often cited in papers is 6 months, so that is what we will use. For a security[6] to qualify for the experiment, it must have been around for at least 2 years. If it crosses the 52 week high, but then either delists or is up to the current date before the holding period expires, we discard that result.  The final result will be calculated as an equally weighted portfolio[7] The results of the experiment will be benchmarked[8] against 2 different buy and hold strategies.  1. Buy and hold the S&P500[9] 2. Buy and hold each equity and take the average.

3. Results

   1. Over a 10 year period, if you were to simply buy and hold every single company ever listed in US markets, you would make an average return of 197%.

   2. If you were to simply buy and hold the S&P 500, you would have earned a return of 268%

   3. If you were to only purchase (sell) securities after they cross their 52 week high (low), you would earn a return of 292% over 10 years. 

4. Discussion on Results

   1. Creating this portfolio would not be feasible, as it does not take into account trading costs or consider the possibility of purchasing a stock whenever it crosses a threshold. What it does demonstrate is the possibility of momentum in the US equities market, even outperforming a buy and hold strategy of the S&P 500.  While this would be a poor strategy on its own, I hope it will be a somewhat useful insight when making shorter term investing decisions.

5. Economic Concepts

   1. There are not many purely economic concepts that explain this momentum phenomena. Behavioral finance attributes momentum in markets to concepts such as herding behavior[10], confirmation bias[11], and overconfidence of investors. The beauty of running our own research, is that we can test, empirically[12], whether or not the phenomena reliably exists, while not having to fully rely on the explanations of so-called "experts."

6. Math & Stats Concepts

   1. During WWII, the military wanted to reinforce their bombers to protect against heavily targeted and vulnerable areas. As they couldn't stick armor everywhere due to the weight, the generals told their mechanics to reinforce the areas with the most bullet holes. This was before mathematician Abraham Wald looked at where most of the bullet holes were landing, and noticed almost all were in the wings/tail, and none of them were through the more vital areas of the airplane. He concluded the reason that the bombers were never hit there is that none of those bombers made it home to be analyzed. If they put armor where their data suggested, the air force would have had a bunch of well armored airplanes in the bottom of the ocean. This was the birth of a term later known as 'survivorship bias[13].'
      

   2. A more obvious example is doing a study of the top tech companies, realizing that many of them were college dropouts, and suggesting  that to be successful they need to drop out of college. This obviously doesn't include all of the college dropouts you see at venice beach and in pioneer park.

   3. When doing statistical market research, particularly on the entire market, it's important to include both listed and delisted[14] companies, both the failures and successes, to be sure that we aren't putting armor around the wings, and cardboard around the engine.

   4. Our momentum test was done using 8,500 listed and 5,000 delisted securities to avoid the so-called 'survivorship bias.' When analyzing data, there will always be outliers due to bad data. I chose to trim the data using an IQR[15] approach. 

7. Coding Concepts

   1. There isn't much interesting to add here. A fun fact is that, when optimized, it takes only 456 nanoseconds to calculate the 52 week high and low, test if the current price is above/below, and calculate the percent change in price over the following 6 months. For comparison, it takes anywhere from 100-400 million nanoseconds to blink an eye.

8. Financial Markets Concepts

   1. Efficient Market Hypothesis (EMH): There is some nuance, but the basic premise is that all information, both public and private, is priced into the value of the equity. As it relates to our experiment, what this theory states is that there shouldn't be any benefit to buying a trending security, because the price should already reflect any optimism investors may have.

   2. The EMH also assumes that investors are rational decision makers. As it happens, there isn't much rationale behind the idea of buying a stock just because it's going up. While this experiment may not be statistically significant, it does raise some questions for the EMH.

   3. There have been some attempts to explain this momentum idea. The authors of 52 week momentum article we reference (there have been many, and these guys certainly aren't the first btw) argue that momentum is caused by the inefficient incorporation of new information into the price of the security. Therefore, when an equity hits highs and continues to push, it is the result of the positive information slowly being adopted by market participants.

9. Further Testing

   • In our main experiment, we only tested 6 months. Here are the average returns for various holding periods. 1 month: 127% 2 months: 152% 3 months: 316% 4 months: 245% 5 months: 284% 6 months: 292% 9 months: 316% 12 months: 256%

---

DEFINITIONS & CONCEPTS

1. Momentum

   1. Momentum is essentially the theory that high performing stocks will continue to perform well, while poorly performing stocks will continue to perform poorly. If this is true, then you should be able to create an effective investment strategy by only purchasing high performers, and selling low performers.

2. Equities

   1. An equity is a pretentious way to say reference a company that is available to trade on the stock market or any other public market.

3. Long

   1. When you go "long" a company, that means that you benefit from an increase in price. It is yet another pretentious way of saying you are going to buy a share of that company. (If you get into an argument with some finance snob about it not being technically right, just know that while that snob may be correct, he isn't your friend)

4. Short

   1. When you are short a company, that means you benefit from a decrease in price. Functionally, when you short a company, you are borrowing the shares, with a promise to buy them back later. Essentially instead of buying low and selling high to make money, you are selling high, and then buying back low.

5. Holding Period

   1. How long you are in the trade. If you go long Apple stock for 6 months, then your holding period is 6 months. Likewise, if you go short Amazon stock for 10 days, then your holding period is 10 days.

6. Security

   1. A security is a broader term that refers to a tradable contract representing a financial asset

7. Portfolio

   1. Another fancy way of saying a collection of stocks you own. If you buy Amazon and Apple stock, you have created a two stock portfolio.

8. Equally Weighted Portfolio

   1. This is best explained with an example. Lets say you have 100 dollars and invest in two stocks, A and B. A costs 10 dollars, and B costs 5 dollars. If you have an equally weighted portfolio, you invest $50 into A, and $50 into company B. Doing it this way means you will end up with 5 shares of company A, and 10 shares of company B.

   2. The previous example is technically a equally weighted portfolio based on price. If you want to have it equally weighted based on shares, then you could buy 6 of A and 6 of B, with some $10 left over.

9. Benchmark

   1. A benchmark is a standard or point of reference against which things can be compared or assessed. In our case we chose a simple strategy of buying and holding the S&P 500, as it is an estimate of the overall economy.

10. S&P 500

    1. The S&P 500 (Standard and Poor 500) tracks the performance of 500 of the largest publicly traded companies in the United States. It is widely regarded as one of the best representations of the U.S. stock market and the overall economy.

11. Herding Behavior

    1. Herding Behavior is the phenomenon that occurs when individuals tend to mimic the actions of others, believing that the majority's actions are more informed or rational.

12. Confirmation Bias

    1. Confirmation bias is a cognitive bias that involves favoring information that confirms one's preexisting beliefs or hypotheses while disregarding or discounting information that contradicts them.

13. Empirical Evidence

    1.  Empirical evidence is evidence that comes by way of observation. Empirical evidence is what we get when we run studies and observe statistics. Theoretical evidence is what we get when we extend out empirical evidence and start building ideas and equations around what we observe.

14. Survivorship Bias

    1. This is discussed at length in the body of the article

15. Listed and Delisted

    1. A listed stock is one that is currently available to trade. A delisted stock is one that has been taken off the public markets for one reason or another. The reasons can vary, anywhere from the company buying back all of the shares, to a company going out of business

16. IQR Method of Trimming Data

    1. IQR stands for Inter Quartile Range. Trimming a dataset using an IQR method means that you find what value is 25% from the biggest value, multiply it by 1.5, and then get rid of all the values above that one. You do the same for the lower portion. There are likely many different variations, but that is the basic idea
       

---

Reference Papers

52-week High and Momentum Investing

---

DISCLAIMER

The information provided is for informational purposes only and does not constitute financial, investment, or other advice. The content is based on our analysis and opinions, which are subject to change without notice. We make no representations or warranties regarding the accuracy, completeness, or timeliness of the information provided. Past performance is not indicative of future results. Always conduct your own research and consult with a qualified financial advisor or investment professional before making any investment decisions. We disclaim any liability for any loss or damage incurred as a result of the use of the information contained in this article.