Bought US Momentum Stocks, Lost 44.3%...Changed 'Strategy' and Losses Plummeted to 2.4%

▲ US stock market/AI generated image

Momentum investing, which involves following stocks that have performed well, resulted in an average loss of 44.3% at its worst moments. However, a study found that by changing just one calculation criterion, the loss rate sharply dropped to 2.4%.

According to the US economic media MarketWatch on July 9 (local time), researchers Pascal Büsing, Hannes Mohrschladt, and Susanne Siedhoff from the University of Münster in Germany proposed a new calculation method that can avoid large losses in momentum investment strategies. A typical momentum strategy involves buying stocks with high returns over the past year and short-selling underperforming stocks, but it sometimes incurs massive losses, referred to as 'momentum crashes'.

Instead of the existing method of comparing prices from 12 months ago and one month ago, the research team calculated the rate of increase from the price 12 months ago to the highest price during the subsequent period. Over the past 100 years, the average loss rate during the 10 worst months for the existing momentum strategy was 44.3%, but the average loss rate for the new strategy was only 2.4%. It also outperformed the existing method in terms of returns and risk-adjusted performance.

MarketWatch cited Hecla Mining (HL) as an example. Under the existing calculation method, Hecla Mining's rate of increase was 140%, but when calculated using the researchers' method, it jumped to 455%. The new strategy used how strongly a stock rose from its past price to its peak, rather than simply how much it rose recently, as the criterion for judging momentum.

The researchers analyzed that the key was to distinguish between high-momentum stocks that maintain near their 52-week high and stocks that peaked and then significantly declined. They explained that stocks that have moved away from their peak suggest that investor sentiment has already started to cool, which helps reduce the risk of a sharp crash in the existing momentum strategy.

MarketWatch applied this method to the Russell 1000 Index (RUI), consisting of US large-cap stocks, to select the 10 stocks with the highest momentum and the 10 with the lowest momentum. The research results proposed a strategy that can reduce past large loss periods while maintaining long-term profits from momentum investing.

[Article Key Summary]

-The existing momentum strategy recorded an average loss of 44.3% in the worst 10 months over the past 100 years, but the new strategy's average loss rate was 2.4%.

-Hecla Mining's momentum increase rate was 140% using the existing method and 455% using the new calculation method.

-The researchers reduced the risk of a momentum crash by measuring the rate of increase from the price 12 months ago to the subsequent highest price.

*Disclaimer: This article is for investment reference only, and we are not responsible for any investment losses based on it. The content should be interpreted for informational purposes only.*