Momentum: Exploiting Human Emotions – Morningstar 10-26-12

Salient to Investors:

History shows investors are more prone to sell “winning” investments but hold on to losers.

Momentum trend-following strategies will lose some money, but probably not all of your money. Avoiding losses is the key advantage of momentum strategies.

Kevin Orr at F-Squared Investments said:

  • Avoid loss, even at the expense of sacrificing upside. Forced selling often occurs in the marketplace, but forced buying doesn’t.
  • Sectors are the “sweet spot” for momentum strategies.
  • If volatility is decreasing,extend the moving averages, thereby allowing them to stay in the market for longer. On the flip side. If volatility is increasing, tighten the moving average indicators.
  • A strategy should have a solid and intuitive basis, so don’t try to outsmart or override what it is telling you.

Mebane Faber at Cambria Investment Mgmt said models can and do evolve over time and should be adjusted for structural changes in the market. For example looking solely at dividends may have been a good strategy but recently corporate share buyback activity has increased significantly so now cannot be ignored.

Momentum and trend-following strategies will tend to underperform when there is no clear trend in a range-bound market.

Read the full article at http://www.morningstar.co.uk/uk/news/96133/Momentum-Exploiting-Human-Emotions.aspx