In this piece Societe Generale looks at ways to improve upon price momentum screens for selecting stocks and avoid the massive drawdowns of 2009.
From the piece:
“Macro news has been dominating stock prices and is likely to continue doing so for the foreseeable future. We calculate that the market is now exerting twice the influence on individual stock prices that it was 10, 20 or 30 years ago. This matters enormously for those who use the
last 30 years as a template for what works (or doesn’t work) in equity markets.
With this heavy influence, the danger of using price momentum factors in a stock selection process is that the portfolio becomes exposed to an underlying macro story (and not company specifics), potentially leading to gut wrenching reversals (losses) when the macro direction
changes. This was certainly the case in the Great Momentum Crash of 2009 and, as such, we believe that traditional price momentum is too dangerous a strategy to pursue.
Earlier this year we suggested that using stock specific price returns (i.e. the part that cannot be explained by the beta of the stock and market performance) instead of regular price returns, delivers better price momentum performance. In this note we introduce several variations to that theme and demonstrate that by adjusting to common factors, price momentum still works, despite elevated macro cacophony.
We also note that poor performance is typically seen if a price momentum strategy is applied when the market is oversold. By reducing our exposure to optionable stocks (i.e. not shorting bombed out stocks that have fallen too much), we can limit the reversal risk on the short-side
and introduce the concept of market distress into our momentum model.”
Chart from the paper here:
Download the full 25 page page PDF here:
Some Simple Tricks to Boost Price Momentum Performance