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Lessons for Investors

If you decide to pursue a price/volume momentum strategy, you have to be a short-term investor and be willing to trade frequently. While the strategy will always be risky, there are ways in which you can reduce your exposure to its limitations. In general, you should consider doing the following:

  • Have a clear strategy based upon empirical analysis. Ultimately, the question of whether momentum carries over into future price changes is an empirical question. While the past is not necessarily prologue, there is evidence of stock price momentum but it is very sensitive to time horizon. Investors therefore have to put their momentum strategies to the test on past data, using specific time horizons to maximize their chances of earning returns.

  • Develop screens to eliminate “troublesome” stocks. Momentum stocks tend to be riskier than the rest of the market and often trade at high prices relative to fundamentals. Since there is a good chance of momentum reversing itself with these highly priced stocks, you should eliminate the riskiest, most overpriced stocks from your portfolio.

  • Execute. Trading costs can very quickly overwhelm any additional returns from a momentum strategy, and these costs can be exaggerated by the need to trade quickly to take advantage of momentum. Keeping trading costs under control is key to success with this strategy.

  • Be disciplined. To earn your promised returns, you have to stay true to your tested strategy. All too often, investors deviate from their strategies when confronted with failure.


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