Stick to Momentum Investing, You Won’t Regret It

Active investing is really difficult. The average investor regularly underperforms the stock market by 4~5%p, according to a research done by Dalbar Inc., a company known for studying investor behaviors and market returns. The S&P 500 Index, on the other hand, has annualized average returns of 13.6%p in the last ten years ending on 7/15/2020, according to global investment bank Goldman Sachs. The case for index investing then, is almost a no-brainer.

But research shows time and again that anomalies challenge this notion that stock prices reflect all available information. Otherwise known as the Efficient Market Hypothesis (EMH), developed by the economist Eugene Fama in the 1960s, the theory holds that markets rapidly take in new information and stock prices are as accurate as they can be. If this were true, index investing might be the only way to ever beat the market. But we all know this isn’t the case. As the ensuing debate between active and passive investing drags on, one thing is for certain: anomalies are critical for finding alpha.

Perhaps the strongest deviation from the theory of market efficiency comes from the historical success of momentum investing.

Momentum Investing 101

For decades, momentum investing has persisted as a somewhat reliable “money-maker” strategy. It involves buying upward trending stocks to maximize long-term profits and selling them once they’ve reached their peak. Essentially, momentum investors work with volatility to try and find opportunities to outperform the overall stock market. It goes against the classic “buy low, sell high” approach and instead focuses on “buying high and selling higher”. This strategy is both risky and rewarding, often times used by many seasoned traders.

In a 1993 study titled Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency (Jegadeesh & Titman, 1993), published in the Journal of Finance by Sheridan Titman and Narasimhan Jegadeesh, both faculty at UCLA at the time, momentum strategy was carefully documented from 1965 to 1989 and saw it had generated higher returns than the overall U.S. market. The authors set a 3~12 month window to determine whether to buy or sell a certain stock. The basic premise for the study relied on two main factors: investors either overreact or underreact to news related to their stocks. In other words, human emotions cause illogical investment decisions, leading the stock prices to stay in the same trajectory for some time.

There are several possible explanations as to why overreaction or underreaction play a critical role in stock price movements:

1. Slow reaction — In theory, investors will react immediately when new information gets released. This will allow prices to reflect the news in real-time. However, this rarely happens because investors may receive news at different times and from different sources. In addition, whenever a company shares its earnings reports, it takes significant amount of time for that news to be totally embraced by the market. This in turn could allow for the stock to stay upward trends for some time.
2. Disposition effect — A popular term in behavioral finance, disposition effect refers to when investors sell winning stocks prematurely to secure gains and hold on to losing stocks to avoid further losses. Investors who suffer from this behavior are likely to underreact to news, which means that whenever a company shares an announcement, prices won’t immediately reflect its actual value.
3. Bandwagon effect — Some investors are prone to reacting fast to market movements. In short, investors can use recent performances as a signal to buy or sell their stocks. The idea is that as more people react to the markets the same way, others will “hop on the bandwagon” and create price movements that could last for several months.

Advantages of Investing with Momentum Strategy

Fortunately, implementing momentum strategies is straightforward and comes with many potential benefits. If done right, investors may generate excess risk-adjusted returns.

1. High profits in short time — Since momentum investors are not concerned about annualized returns, they try to capitalize on short-term gains. For example, if a stock doubles in value after a few weeks, you can immediately sell and lock in the profits.
2. Utilize market volatility — Momentum investors usually have a high-risk tolerance. This means they try to leverage volatility to maximize their returns and ensure they follow or avoid market movements.
3. Capitalize on human emotions — By identifying what’s known as a “herd mentality,” momentum investors can apply a systematic process to potentially capture excess returns. They don’t give into their emotions, but rather use technical indicators to find buying and/or selling opportunities.

A major downside to momentum investing is that investors need a good deal of time, energy, and knowledge to successfully pick the right trending stocks. This means that investors need to carefully monitor the markets daily. One way to offset this disadvantage is to adopt smart beta2 products that offer investors exposure to various momentum strategies. Smart beta investing is neither active nor passive investing. It’s a little bit of both. The ultimate goal of smart beta is to achieve alpha at lower risk and cost. Take for example the iShares Edge MSCI USA Momentum Factor ETF (BATS: MTUM), which is one of the most well-known ETFs that leverage the momentum factor. Since inception in 2013, the fund has grown to $12.5 billion in AUM and has repeatedly outperformed the S&P 500 Index benchmark.

Featuring Qraft AI-Enhanced U.S. Large Cap Momentum ETF (NYSE: AMOM)

While momentum investing is not foolproof, there is no doubt that the strategy works. At Qraft Technologies, Inc., we leverage this momentum factor and combine it with our AI system to create AI-powered ETF called the Qraft AI-Enhanced U.S. Large Cap Momentum ETF (NYSE: AMOM).

AMOM is an actively managed portfolio of U.S. large cap stocks, handpicked directly by AI technology. It tracks the top 50 U.S. large cap companies that capitalize on the movements of existing market trends. It is the world’s first AI-driven ETF that focuses primarily on momentum stocks. Since inception on 5/21/19 on the New York Stock Exchange until 12/31/20, AMOM has outperformed its benchmark S&P 500 Index.

AMOM is available to purchase on various brokerage accounts, including Fidelity, Charles Schwab, TD Ameritrade, E-Trade, Robinhood, and more. Please note that you cannot invest in AMOM directly through Qraft Technologies, Inc.

Key Takeaway

When properly implemented, momentum investing is a time-tested strategy that has worked against the efficient market theory. Elaborate studies have shown that this is in fact a viable strategy that brings potential excess risk-adjusted returns for retail and institutional investors. With smart beta momentum ETFs offering convenience and cost-efficiency, we believe there is little to no reason why investors shouldn’t leverage this factor as part of their overall investing strategy.

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Investors should consider the investment objectives, risks, charges, and expenses carefully before investing. For a prospectus or summary prospectus with this and other information about the Fund, please call 1–855–973–7880 or visit our website at www.qraftaietf.com. Read the prospectus or summary prospectus carefully before investing.

The Funds are distributed by Foreside Fund Services, LLC

Investing involves risk, including loss or principal. The Qraft Funds are subject to numerous risks including but not limited to: Equity Risk, Sector Risk, Large Cap Risk, Management Risk, and Trading Risk. The Funds rely heavily on a proprietary artificial intelligence selection model as well as data and information supplied by third parties that are utilized by such model. To the extent the model does not perform as designed or as intended, the Fund’s strategy may not be successfully implemented and the Funds may lose value. Additionally, the funds are non-diversified, which means that they may invest more of their assets in the securities of a single issuer or a smaller number of issuers than if they were a diversified fund. As a result, each Fund may be more exposed to the risks associated with and developments affecting an individual issuer or a smaller number of issuers than a fund that invests more widely. A new or smaller fund’s performance may not represent how the fund is expected to or may perform in the long term if and when it becomes larger and has fully implemented its investment strategies. Read the prospectus for additional details regarding risks.

QRAFT AI-Enhanced U.S. Large Cap Momentum ETF: The Fund is subject to the risk that market or economic factors impacting technology companies and companies that rely heavily on technology advances could have a major effect on the value of the Fund’s investments. The value of stocks of technology companies and companies that rely heavily on technology is particularly vulnerable to rapid changes in technology product cycles, rapid product obsolescence, the loss of patent, copyright and trademark protections, government regulation and competition, both domestically and internationally, including competition from foreign competitors with lower production costs. Technology companies and companies that rely heavily on technology, especially those of smaller, less-seasoned companies, tend to be more volatiles than the overall market.

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Alpha is a measure of the active return on an investment, the performance of that investment compared with a suitable market index.

Smart Beta defines a set of investment strategies that emphasize the use of alternative index construction rules to traditional market capitalization-based indices.

Sources:

Jegadeesh, N., & Titman, S. (1993). Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency. The Journal of Finance, 48(1), 65–91.