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

Australian stocks will crush housing over the next decade, one year on

Last year, I wrote an article suggesting returns from ASX stocks would trample those from housing over the next decade. One year later, this is an update on how that forecast is going and what's changed since.

What to expect from the Australian property market in 2025

The housing market was subdued in 2024, and pessimism abounds as we start the new year. 2025 is likely to be a tale of two halves, with interest rate cuts fuelling a resurgence in buyer demand in the second half of the year.

Howard Marks warns of market froth

The renowned investor has penned his first investor letter for 2025 and it’s a ripper. He runs through what bubbles are, which ones he’s experienced, and whether today’s markets qualify as the third major bubble of this century.

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.

9 lessons from 2024

Key lessons include expensive stocks can always get more expensive, Bitcoin is our tulip mania, follow the smart money, the young are coming with pitchforks on housing, and the importance of staying invested.

The 20 most popular articles of 2024

Check out the most-read Firstlinks articles from 2024. From '16 ASX stocks to buy and hold forever', to 'The best strategy to build income for life', and 'Where baby boomer wealth will end up', there's something for all.

Latest Updates

Investment strategies

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.

Shares

The case for and against US stock market exceptionalism

The outlook for equities in 2025 has been dominated by one question: will the US market's supremacy continue? Whichever side of the debate you sit on, you should challenge yourself by considering the alternative.

Taxation

Negative gearing: is it a tax concession?

Negative gearing allows investors to deduct rental property expenses, including interest, from taxable income, but its tax concession status is debatable. The real issue lies in the favorable tax treatment of capital gains. 

Investing

How can you not be bullish the US?

Trump's election has turbocharged US equities, but can that outperformance continue? Expensive valuations, rising bond yields, and a potential narrowing of EPS growth versus the rest of the world, are risks.

Planning

Navigating broken relationships and untangling assets

Untangling assets after a broken relationship can be daunting. But approaching the situation fully informed, in good health and with open communication can make the process more manageable and less costly.

Beware the bond vigilantes in Australia

Unlike their peers in the US and UK, policy makers in Australia haven't faced a bond market rebellion in recent times. This could change if current levels of issuance at the state and territory level continue.

Retirement

What you need to know about retirement village contracts

Retirement village contracts often require significant upfront payments, with residents losing control over their money. While they may offer a '100% share in capital gain', it's important to look at the numbers before committing.

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.