Momentum Investing Versus Bottom Fishing
(You won’t believe the difference it makes!)
by Momentum Alert Research Team
Way too many investors love to “bottom fish.”
A bottom-fisher is an investor who looks for bargains among stocks whose prices have recently dropped dramatically. He believes that the price drop is temporary or is an overreaction to recent bad news and a recovery is soon to follow.
“It’s down so much, I can’t go wrong,” they say.
Unfortunately, much more often than not, there dead wrong…
What is certain is that when bottom fishing for stocks, you are rarely going to find a prize. Instead it’s likely to be a company facing some sort of issue that is going to take a long time to resolve itself.
Here’s what James O’Shaughnessy, author of What Works on Wall Street has to say about the strategy: “If you’re looking for a great way to underperform the market, look no further.”
In fact, you’d have made a fortune doing the opposite… investing in the top performing stocks – the best momentum stocks – over the preceding months.
And O’Shaughnessy can back up his statement.
O’Shaughnessy sliced and diced the stock market in his book, sizing up nearly every possible way to make money in stocks – usually going back over 80 years. And he found that buying what has fallen the most is one of the worst strategies.
O’Shaughnessy’s conclusion is: “Unless FINANCIAL RUIN is your goal, avoid the biggest losers.”
Looking back at eighty years of stock data, here’s what O’Shaughnessy found:
If you’d bought the top 10% of performers (the best momentum stocks) over the preceding six months for each time period he looked at, you’d have made more than half a billion dollars.
If you’d “bottom-fished” and bought the bottom 10% of performers over the previous six months you’d have made less than $293,000… about 0.05% as much.
Which would you prefer? More than $500 million… Or less than $300,000?
It’s All About Momentum
His study shows that buying what was already “up” proved incredibly successful…
“Over six-month and 12-month periods, winners generally continue to win and losers general continue to lose,” O’Shaughnessy writes.
And owning the most recent crop of momentum stocks (without taking on unnecessary risk) – allows you to do just that. It’s a common sense approach to investing that works in good markets, and in bear markets, too. It doesn’t depend on
what the market averages are doing. Or whether your fund manager is on or off his game.
Momentum stocks are, by definition, the fastest-growing companies – and the most rapidly moving stocks – in the market. There’s nothing mysterious about them. Quite simply, they lead virtually all other companies in terms of sales growth, operating margins, profitability and “relative strength.”
As O’Shaughnessy points out; the key to making money in a short time (and a fortune over the long-haul) is to invest in the best performing stocks over the preceding months.
So the next time you hear someone say his main strategy is to buy what has fallen a lot recently; realize this person has no idea what actually works.
What works is buying what was up, not down. Simply buying what was up over the previous six months turned $10,000 into over $500 million. Doing the opposite performed far worse than the stock market (with much more volatility, too).
Do what works… invest in momentum stocks. History shows you’ll be well-rewarded if you do.