Momentum trading is based on a rather simple observation: Investments that go up tend to keep outperforming; those that underperform often remain laggards. This kind of trading might seem too simple a stock-picking strategy to work. Yet it often has. Returns can be amplified when investors don't just go long on outperformers, but also short underperformers. The S&P 500 Momentum Index soared 44% in the second quarter, its best quarterly performance on record, and it surged 133% over the past five years, nearly double the broad market’s performance. Alas, as any believer in regression to the mean would have predicted, as this WSJ article reports, suddenly, the trade is a loser. The momentum index has tumbled more than 9% since July 1, lagging behind the S&P 500’s 2.8% gain. The index—which tracks stocks in the S&P 500 based on a “momentum score”—is on track for the biggest quarterly underperformance in 25 years. July was the second worst month for the momentum trade in around 40 years--the only month worse was April 2009, in the teeth of the global financial crisis.
[EOP]
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