Momentum is a phenomenon that tends to leave academics scratching their heads as it shouldn't really exist in a world of perfectly efficient markets. Yet for 100 years a simple rules based, quantitative approach would have provided the opportunity to earn increased returns with reduced volatility and drawdowns vs. a buy and hold approach.
Buy the Winners
Eugene Fama, Father of the Efficient Market Hypothesis (EMH), has referred to momentum as "the premier market anomaly" which represents "the biggest embarrassment for Efficient Market Theory". And it's also very simple. So simple that it's under appreciated.
I'm going to paraphrase about a five minute clip of the podcast which can be heard here. I highly recommend it.
The podcast
Covel: Losses are statistically inevitable. There are still a number of people out there, some astute and some not, that still don’t want to imagine losses as a part of the game.
Kirk: Yep, people are desperate
The reality is that maybe the best you can look for over a long period such as 20 or 30 years is a Sharpe ratio of .8, .9, maybe 1.
Take a simulation of a 20% volatility with a 20% return per year. Every 2 years you will have a drawdown of 15% statistically, and a 20% drawdown every 4 years. And you don’t have to run very many simulations before you get a 40% drawdown that can last five years. Remember, this (simulation) is something that is guaranteed
Summary
The enemy of a good plan is the dream of a perfect plan. Drawdowns and losses are part of the game but your human nature of survival will put up a fight against rationality when drawdowns occur. The human brain is capable of incredible optimism as well as pessimism. Be aware of it, and have expectations that are statistically valid. Not just past performance.
Jesse Blom is a licensed investment advisor and Vice President of Lorintine Capital, LP. He provides investment advice to clients all over the United States and around the world. Jesse has been in financial services since 2008 achieving multiple industry achievements including qualifying membership in the Million Dollar Round Table for 5 consecutive years. Membership in this prestigious group represents the top 1% of financial professionals in the world. Jesse has a Bachelor of Science in Finance from Oral Roberts University.
Jesse is managing the LC Diversified portfolio.
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