Regular readers of the Stockpot column might recall the late, unlamented “Bombed Out but Bouncing Back” (BOBB) portfolio that was based on momentum investing.
The virtual portfolio’s disastrous performance offered me plenty of opportunities to be more than a bit sniffy about the concept of momentum investing – buying shares that have gone up a lot in price (relative to their peers) in the hope they will continue to outperform – but there is plenty of academic research to suggest that the strategy has merit.
The system is also fairly easy to implement and does not require any of that hard grind value investors go through, poring over the profit & loss accounts of companies trying to work out which ones are undervalued.
All an investor has to do is pick a universe of stocks – say, companies with a market capitalisation of more than £1bn – and a time-period over which to determine the best performers – say, six months or a year – and then pick a cut-off point to determine how many shares to buy.
Having whittled the list down to five or ten stocks or whatever, the investor then invests an equal amount in each and then repeats the process at regular intervals – say, every two or three months – to rebalance the portfolio.
For some, the concept of backing winners makes a lot of sense; it’s certainly a well-followed idea in sports betting, although obviously the circumstances are slightly different, as bookmakers can adjust the odds in their favour to such an extent that backing Manchester City to beat, say, lowly Wigan Athletic, is barely worth the risk.
For others, the whole idea of backing a stock that has already shot up (say) 40% in the last three months provokes the agony of wondering whether they have missed the boat.
Apparently, in many cases, the “missed the boat” fear is a losing mentality (says the man who decided he had missed the boat when Google’s share price doubled in its first year as a floated company to US$100; it now trades at US$1,160, or thereabouts).
Hit or myth?
According to a paper published in May 2014 by Clifford Asness, Andrea Frazzini, Ronen Israel and Tobias Moskowitz, US equity data spanning more than 200 years supports the idea that a momentum-based investment strategy is, more often than not, a successful one.
“Some of this evidence predates academic research in financial economics, suggesting that the momentum premium has been a part of markets since their very existence, well before researchers studied them as a science,” the authors wrote.
“However, as momentum strategies have grown in popularity, so have myths around them. Some of the most common myths are that momentum is too “small and sporadic” a factor, works mostly on the short-side, works well only among small stocks and doesn’t survive trading costs. Furthermore, some argue that momentum is best used as a ‘screen’, not as a regular factor in an investment process. Others will go so far as to say that momentum investing is like a game of ‘hot potato’, implying that it isn’t a serious investment strategy, with no theory or reasonable explanation to back it up,” they wrote.
The fact that the authors referred to these as myths tells you which side of the momentum argument they are on.
If you are truly interested in their myth-busting treatise on momentum investing, it is available on the internet.
In our ill-fated experiment with the BOBB portfolio, we possibly tried to get a bit too cute (or greedy) by restricting our universe to “bombed out” stocks that had fallen 33% or more over the last year but which had been on a rising trend over more recent time periods (five days, 10 days, one month).
If we had adhered to a recognised momentum investing strategy, we’d actually have been shorting those stocks that had lost 33% or more over the last year, irrespective of the recent trend.
Back the winners until they stop winning
As it is relatively simple to do – or it will be the way we do it - it is, perhaps, time to give the old “momentum investing” strategy a proper try. To make it a bit more interesting I am going to draw on three separate groups of stocks, and see which ones do the best.
The three groups are:
- Stocks with a market capitalisation of less than £100mln – the tiddlers
- Stocks with a market capitalisation of between £100mln and £1bn – the middlers
- Stocks with a market cap of more than £1bn – the … er … biglers.
Now comes the tricky part: setting the “whittling down” parameters and deciding how often to rebalance the portfolio.
Following the “keep it simple, stupid” (KISS) principle and avoiding getting involved in the reading of tea leaves, throwing of knuckle-bones, groping through sheep’s entrails and the deciphering of runes that is technical analysis, I have decided simply to pick ten stocks from each universe that have risen the most over the last year, invest an equal amount in each and then rebalance the portfolio every two months (i.e. run the screen again, dumping those that fall out of the top ten and reinvesting the proceeds in the new entrants).
Two of the drawbacks – or “myths”, if you prefer – of rebalancing a portfolio every two months are the dealing costs and the bid/offer spread (the difference in price at which you sell and buy), so in this virtual portfolio I will be factoring in the bid/offer spread and an assumed £15 in dealing costs.
I’ll not be factoring in stamp duty because, as a former colleague of mine used to observe, “life’s too long” and I don't want to get to the end of it and realise I have spent 73 hours calculating stamp duty on an entirely fictitious portfolio.
So, we’re under starter’s orders … and we’re off!
The Tiddlers
Company
Ticker
% change (1 yr)
Relative Strength Index (66 periods)
50-day moving average
Offer price
Zoo Digital
LON:ZOO
740%
63.2
69.78p
89p
Rockrose Energy
LON:RRE
700%
89.9
196.42p
364p
N4 Pharma
LON:N4P
390%
57.5
21.97p
25p
Spectra Systems
LON:SPSC
340%
87.5
97.95p
120p
Elektron
LON:EKT
310%
74.6
22.63p
29.6p
LON:BIOM
290%
63.4
294.82p
380p
AorTech
LON:AOR
260%
55.4
46.87p
49p
One Media IP
LON:OMIP
210%
61.9
8.88p
9.75p
UniVision Engineering
LON:UVEL
190%
55.7
2.01p
2.4p
Weatherly International
LON:WTI
180%
54.7
1.88p
1.95p
The Middlers
Company
Ticker
% change (1 yr)
Relative Strength Index (66 periods)
50-day moving average
Offer price
Versarien
LON:VRS
400%
56.8
85.07p
88p
Yu Group
LON:YU
360%
68.9
1,048.7p
1,260p
Bluejay Mining
LON:JAY
220%
56.7
23.56p
26p
LON:ARS
200%
58.4
10.27p
12.25p
LON:OXB
170%
60.9
11.02p
12.72p
Griffin Mining
LON:GFM
150%
59.6
126.86p
130p
LoopUp Group
LON:LOOP
140%
62.5
336.55p
388p
Silence Therapeutics
LON:SLN
120%
53.0
195.75p
206p
StatPro Group
LON:SOG
110%
62.7
164.17p
187p
LON:TMT
110%
65.2
US$3.21
US$3.70
The Biglers
Company
Ticker
% change (1 yr)
Relative Strength Index (66 periods)
50-day moving average
Offer price
Blue Prism
LON:PRSM
240%
59.0
1,408.5p
1,690p
IQE
LON:IQE
200%
52.9
123.09p
144p
Keywords Studios
LON:KWD
170%
61.0
1,527.56p
1,834p
Plus500
LON:PLUS
160%
54.5
1,107.99p
1,116p
Ocado Group
LON:OCDO
120%
68.0
489.42p
596.6p
Hutchison China
LON:HCM
110%
54.8
5,120p
5,160p
Evraz
LON:EVR
110%
61.3
392.36p
447p
LON:KAZ
94%
54.9
861.75p
895.4p
LON:SCT
89%
68.1
546.48p
644p
NMC Health
LON:NMC
84%
57.6
3,282.64p
3,450p
I know I said I would not be going anywhere near technical analysis and all that voodoo stuff but for those of you that are au fait with that sort of thing, I have included the relative strength index (RSI) for each stock over 66 trading days and also a 50-day moving average.
The RSI was developed by Wells Wilder and is a “momentum oscillator” that measures the speed and change of price movements. Traditionally, an RSI of more than 70 indicates a stock is moving into “overbought” territory – it has moved too high, too quickly – whereas an RSI of less than 30 indicates a stock is oversold.
If we had nothing better to do all day than stare at screens and check on stock prices, we could trigger a sell whenever a stock moves above an RSI of 70 but we haven’t, so I have included it for information purposes, just to see whether those with a lower RSI have a better chance of surviving the next rebalancing in two months’ time than do those with a high RSI.
Similarly, we could trigger an automatic sell any time a stock’s bid price moves below its 50-day moving average, as this is considered a ‘sell’ signal in some circles. We’re not going to do that, but readers might find it informative to compare the stock’s current price with its 50-day moving average.
We'll revisit the three portfolios to see which is doing the best; logic would suggest that it will be the tiddlers, as they seem to generate bigger percentage changes over a year than the others but we shall see.