Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 117

Momentum of winning and losing share prices

In the spirit of recognising that there are many different ways to pick stocks, a year ago I wrote an article, Stock market winners versus losers, on using a basic momentum strategy to select stocks. The premise went as follows: academic researchers have found that portfolios of recent outperformers did better than portfolios of recent underperformers. So a long short strategy constructed this way should generate a positive return. We tested this approach in the Australian marketplace and found what appears to be a volatile but high performing strategy. How did this strategy perform in the most recent financial year?

2014-15 financial year performance

A brief refresher on the strategy:

  • At the start of each financial year we hypothetically go long an equally weighted portfolio of the previous financial year’s top 10 performing stocks on the ASX 200
  • We hypothetically also short an equally weighted portfolio of the previous financial year’s worst 10 performing stocks on the ASX 200
  • This portfolio is held untouched for the subsequent financial year (i.e. a 12 month holding period).

The table below lists stocks we would have held, long and short, during the previous financial year (2014 / 2015), based on their performance over the previous 12 months, along with their subsequent performance.

Using the table, if we subtract the short performance (-7%) from the long performance (+10%) we end up with a total performance of 17%. The last financial year has been another solid year of performance for this strategy; a little less than the long term average. The chart below presents the updated track record (now 11 years).

Data: Acadian Asset Management (Australia) Limited

The performance numbers above only focus on the active return piece and leave out cash returns, stock borrowing fees and transaction costs (in theory if you have long and short positions of the same dollar amount then you have 100% of the portfolio earning cash returns).

Digging deeper into the theory

This strategy is a simple one. In fact it catches two known theories in one strategy. First there is the cross-sectional momentum strategy between individual stocks, first identified in 1993 by academics Narasimhan Jegadeesh and Sheridan Titman (their paper was titled “Returns to buying winners and selling losers: implications for stock market efficiency”). However the strategy does not control for sector bets (nor did that of Jegadeesh and Titman) and so we are potentially exposed to a cross-sectional momentum strategy between industries. This has been shown to explain much of the performance of the individual stock effects described above. This was identified by Tobias Moskowitz and Mark Grinblatt in their paper titled “Do Industries Explain Momentum?”.

In practice …

In practice it is unlikely that we would see a strategy like this offered as an investment fund, since:

  • The high volatility of the strategy may make it unpalatable
  • The ability to borrow underperforming stocks may prove difficult and costly.

However in practice we find momentum is a strategy commonly applied by many fund managers, typically those who adopt a quantitative approach. Specifically most fund managers would control the size of the sector bets, hence ruling out the simple strategy presented here. Nonetheless many quant managers use momentum as an indicator of performance for stocks and sectors. It would commonly form part of a suite of signals; indeed I have never seen a fund manager offer a momentum-only stock strategy.

Takeouts

As stated last year: I am not recommending you replicate this ‘strategy’ – I wouldn’t myself. And as per last year I don’t tell you the current positions such a portfolio would be holding – you have to do your own homework! The point of this article is to remind you that there are many different ways to pick stocks. Some are based on company analysis, some are technical, and some are behavioural. You need to pick out an approach that you believe you can execute well, understand  its strengths and weaknesses and the markets in which it will work well and in which it may struggle.

 

David Bell is Chief Investment Officer at Mine Wealth + Wellbeing (formerly Auscoal Super). He is also working towards a PhD at University of NSW. This article is for general education purposes only and does not consider the personal circumstances of any investor.

 

RELATED ARTICLES

Does currency hedging provide an edge?

Social media’s impact is changing markets

Why caution is needed in Aussie small companies

banner

Most viewed in recent weeks

Retirement is a risky business for most people

While encouraging people to draw down on their accumulated wealth in retirement might be good public policy, several million retirees disagree because they are purposefully conserving that capital. It’s time for a different approach.

The perfect portfolio for the next decade

This examines the performance of key asset classes and sub-sectors in 2024 and over longer timeframes, and the lessons that can be drawn for constructing an investment portfolio for the next decade.

UniSuper’s boss flags a potential correction ahead

The CIO of Australia’s fourth largest super fund by assets, John Pearce, suggests the odds favour a flat year for markets, with the possibility of a correction of 10% or more. However, he’ll use any dip as a buying opportunity.

The challenges with building a dividend portfolio

Getting regular, growing income from stocks is tougher with the dividend yield on the ASX nearing 25-year lows. Here are some conventional and not-so-conventional ideas for investors wanting to build a dividend portfolio.

How much do you need to retire?

Australians are used to hearing dire warnings that they don't have enough saved for a comfortable retirement. Yet most people need to save a lot less than you might think — as long as they meet an important condition.

Welcome to Firstlinks Edition 594 with weekend update

It’s well documented that many retirees draw down the minimum amount required and die with much of their super balances untouched. This explores the reasons why and some potential solutions to address the issue.

  • 16 January 2025

Latest Updates

Investment strategies

UniSuper’s boss flags a potential correction ahead

The CIO of Australia’s fourth largest super fund by assets, John Pearce, suggests the odds favour a flat year for markets, with the possibility of a correction of 10% or more. However, he’ll use any dip as a buying opportunity.

9 ways to fix Australia's housing crisis

Decades of policy failure have induced a fall in housing affordability. Unless painful changes are made, an underclass will emerge in a society that is supposed to boast the one of the world's highest standards of living.

Shares

Australia: why the chase for even higher dividend yields?

Australia boasts one of the world's highest dividend yielding sharemarkets, providing substantial benefits to investors and retirees. Despite this, individuals often stretch for even more yield, to their detriment.

Shares

MIGA – Make Income Great Again

The Australian sharemarket seems to be rewarding a number of unprofitable companies on the promise of future riches. Yet profits and cashflows still matter, as a recent case study of Domino's Pizza shows.

Shares

Mapping future US market returns

Exceptional returns from the US sharemarket over the past decade have driven by sales growth, margin expansion, rising valuations, and dividends. Predicting future returns requires careful consideration of these factors.

Shares

Read this before you go all in on US equities

US equities rule global markets, but history is littered with examples of markets that seemed invincible — until they weren’t. Diversification will be key for investor portfolios going forwards.

Property

What impact would scrapping stamp duty have on housing?

Increasing house prices pose challenges for housing affordability. This investigates the impact of stamp duty on the property market, and how removing the tax could help address several key issues.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.