My Journey in Finance: Why Momentum Works
Disclaimer: Your capital is at risk. This is not investment advice.
In this new series of articles, My Journey in Finance, I wanted to explain why the ByteTree investment process is what it is. It is built on personal experience, having begun my investment journey as an amateur in 1992 and professionally since 1998. In that time, I have come across many different companies, cycles, investment approaches, funds, services, market conditions and theories; some of them were good, but most were bad. If there is one thing I have learned above all, there are no quick fixes in finance. In this series, I will go through some of the lessons I have either personally experienced or witnessed, and share what I learned from them.
I latched onto the momentum effect around 2001, having completed my training in technical analysis in 1999 with the UK Society of Technical Analysts (STA). I came to realise there was much more to historical price data than meets the eye. Some investors have used charts with great success with tools like momentum, trend-following and pattern recognition. They succeeded where most failed because their objective interpretation increased their odds rather than reaffirming a personal bias. People see what they want to see.
A key point about charts is not just the study of a single asset, but how that asset compares to other opportunities in the market. For example, a rising trend is normally a good thing, but if that trend is rising at a snail’s pace, then don’t expect magic to happen. Better to find trends that are not only rising but beating the market to boot. Hence the momentum effect doesn’t just focus on trends, but the strongest trends. This is what differentiates momentum investors from trend followers.
Using a football analogy, it is obvious that a good striker will continue to score more goals than a player selected at random. But then the striker becomes worth millions in the transfer market, and whether they score enough goals per million is another matter. Given the games result in a win or a loss, what does it matter? The winning teams need the best players, so the team owners just pay up. Great footballers are valued at their marginal edge, which makes them a price-inelastic luxury good.
It's the same in momentum stocks. The best advertising strategy for an investment is a rising price. The longer they keep going, the more the excitement builds, and the result is always euphoria. Momentum investors are hunting for euphoria.
