More on Momentum Losing Momentum

The world’s easiest timing strategy, only invest after up days, was a huge winner for many decades, but not anymore.
Check out the chart below:

The blue line is what you would have earned if you had only invested on days following stock market advances (dividends aren’t included). The red line is for days following 0.5% advances. The green line is days following 1% advances, and the black is the S&P 500.
By early 2000, the blue line had returned over 5,000-fold which lapped the S&P 500 by 60 times. Unfortunately, it’s not a very practical trading strategy, considering how often you have to go in and out of the market. Still, that’s one of the more astonishing figures I’ve ever calculated, especially considering how simple the rule is.
Since 2000, however, the strategy has been a bust. The blue line is still below half its peak from eight years ago. It’s not just the burst of the tech bubble, the blue has done especially poorly in the past year. Here’s the blue line again, but only over the past few years (and no log scale):

So what’s going on here? One answer is that an efficient market has simply caught up with a good idea and it no longer works.
But I think another explanation could be, it’s the result of a subtle shift in the nature of the market. Instead of being trend-enforcing, the market has become trend-negating. Each up move is no longer confirmed, but is now fought. If so, I think that’s a healthy development for the market.
But that’s just speculation on my part. What do you think?

Posted by Eddy Elfenbein on June 4th, 2008 at 1:28 pm

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