Momentum and Overreaction Anomalies

Overreaction

Investors tend to inflate (depress) stock prices of companies that have released good (bad) news.

Studies have shown that "losers" (stocks that have witnessed a recent price decline due to the release of bad news) have outperformed the market in subsequent periods, while winners have underperformed in subsequent periods.


Momentum

Other studies have also shown that securities that have outperformed in the short term continue to generate high returns in subsequent periods (carrying on price momentum).



Note:  The overreaction and momentum anomalies go against the assertions of weak-form efficiency in markets.

How permanent are trends?

Wall Street's judgment has been influenced by past trends more than by any other single factor related to security values.

The avowed object of people in the market is to anticipate future developments, and the past is held to have no significance except as it aids in such anticipation.

Yet in practice it is almost the universal habit to base forecasts of future happenings on a projection of past trends.

This is notoriously true of both the professional's and the public's view of market prospects.

Nearly everyone is optimistic (or "bullish") because the market has been enjoying a spirited advance and pessimistic (or "bearish") after a decline.

In the same way, an industry or a company which has grown in the past is almost always expected to keep on progressing; those which have been on the downgrade are expected to get worse and worse.


Momentum

It is true that every established trend has a certain momentum, so that it is more likely to continue for at least a while longer than it is to reverse itself at the moment of observation.

But this is far from saying that any trend may be relied upon to continue long enough to create a profit for those who "get aboard."

Rather extensive studies which we have made of the subject lead us to conclude that reversals of trend in every part of the financial picture occur so frequently as to make reliance on a trend a particularly dangerous matter.  

There must be strong independent reasons for investing money on the expectation of a continuance of past tendencies, and the investor must beware lest his weighing of future probabilities be unduly influenced by the trend line of the past.

Can money be made on balance by following the trend of the general market?  This subject is too complicated and controversial to admit of our treating it her with out own selection of statistical evidence.

But it is appropriate to point out (a) that playing the trend is the standard formula of stock market trading by the general public and (b) that the general public loses money in the stock market.


Industrial groups

The public has a similar tendency to speculate in those industrial groups which have established the best market records in the recent past.  It is easy to show that this naive effort to exploit a historical trend is dangerous.

The trend of industry profits is no more reliable than that of industry prices.

Using earnings as a percentage of invested capital, between 1939 and 1947  we find that the average of the five best industries declined from 24.6% to 17.7%, whereas that of the five poorest advanced from 4.2% to 18.5%.

War conditions and their aftermath, of course, have played an important part in bringing about this extraordinary change in the relative position of prosperous and non-prosperous industries.

There are many unexpected reasons for the changed performance; the important thing is that performance trends do change and investment values with them.


Benjamin Graham
The Intelligent Investor

Martin J. Pring's Trading Rules - Webinar

Rule 1: When in Doubt Stay Out
Rule 2: Never Invest or Trade Based on Hope
Rule 3: Act on Your Own Judgment or Else Absolutely and Entirely on the Judgment of Others
Rule 4: Buy Low (into weakness), Sell High (into strength)
Rule 5: Don't Overtrade

Rule 6: After a Successful and Profitable Trading Campaign, Take a Trading Vacation
Rule 7: Take a Periodic Mental Inventory to Check How You Are Doing
Rule 8: Constantly Analyze Your Mistakes
Rule 9: Don't Jump the Gun
Rule 10: Don';t Try to Call Every Market Turn

Rule 11: Never Enter into a Position Without First Establishing a Reward to Risk
Rule 12: Cut Losses Short, Let Profits Run
Rule 13: Place Numerous Bets on Low Risk Ideas
Rule 14: Look Down (at the risk potential) not Up (before your reward potential)
Rule 15: Never Trade or Invest More Than you Can Reasonably Afford

Rule 16: Don't Fight the Trend
Rule 17: Whenever Possible Trade Liquid Markets
Rule 18: Never Meet a Margin Call
Rule 19: If You are Going to Place Stop, Put it in a Logical, Not Convenient Place

How do investors "chase the market"? It this a bad thing?

	How do investors "chase the market"? It this a bad thing?
Generally, an investor "chases the market" when he or she enters into a highly priced position after the stock price has increased rapidly or become overpriced. An investor who exits a position after the security has lost considerable value also is said to be chasing the market. Both positions suggest that the investor chased the market by following trends unwisely. Many investors unknowingly chase the market and endure large losses as a result. During the dotcom bubble, for example, many investors sought to profit from buying shares of internet and technology companies that were doing well. The popularity of dotcom companies eventually dropped and the investors who had chased the market were left with big losses. Investors who chase the market typically make investment choices based on emotion rather than careful consideration of market trends using statistics and financial data. For this reason, this strategy has been widely criticized and most financial advisors warn against it For more on this topic, read When Fear and Greed Take Over and The Madness of Crowds. This question was answered by Bob Schneider.

Read more: http://www.investopedia.com/ask/answers/09/chase-the-market.asp?partner=basics122311#ixzz1hPJzapcB

Malaysian stocks on bullish sentiment

Wednesday January 5, 2011

Malaysian stocks on bullish sentiment boosted by US data
By LEE KIAN SEONG
lks@thestar.com.my


PETALING JAYA: The FTSE Bursa Malaysia KLCI hit a new high yesterday, closing 18.47 points higher at 1,551.89, on high volume and positive investor sentiment.

Trading volume swelled to over two billion shares as investors were cheered by encouraging data from the United States and regional markets buoyed by rising liquidity.

After a long absence, Malaysia is also back on the radar screen of many international houses.

HwangDBS Investment Management Bhd head of equities Gan Eng Peng noted that last month, manufacturing in the United States grew at its fastest clip in seven months, sending US stocks to two-year highs.

“Investors' reaction was supported by encouraging data from the United States that suggested the economy is improving. Stocks in the United States did well on the first day of trading for the year, and investors call it the January barometer',” he told StarBiz.

Data released in the US on Monday indicated that the manufacturing sector grew in December at its fastest pace in seven months, reinforcing recovery signs.

Gan said foreign investors were increasingly confident about investing in countries like Malaysia.

“For the first time in many years, international research houses have recommended Malaysia as a stock market investment destination over and above many other markets in Asia Pacific .

“If you take this in the context where foreign ownership of stocks remains near historic lows, there could be a lot more buying activity, going forward,” Gan said.

Among the top gainers yesterday were British American Tobacco (M) Bhd which rose 60 sen to RM46.40; Sime Darby Bhd (+ 51 sen to RM9.46); Nestle (M) Bhd (+42 sen to RM43.84) and Ekovest Bhd (+ 37 sen to RM2.74).

Among regional bourses, the Nikkei 225 rose 169.18 points to 10398.10; Hang Seng Index (+232.43 points to 23668.48) and Straits Times (+14.52 points to 3250.29).

Gan said the multiple catalysts announced under the Economic Transformation Plan (ETP) and Budget 2011 would essentially benefit key stock market sectors like construction, building materials and property.

The ETP, if successfully implemented, would help to sustain the momentum.

An analyst from a local investment bank said the gains yesterday on the local bourse was in line with performance of the regional markets with positive news flow from the expected elections in Malaysia.

He said the current resistance level was between 1,560 and 1,570 points while support is between 1,505 and 1,500 points.

Fortress Capital Asset Management chief executive officer Thomas Yong said the rally in the stock market was not only in Malaysia but across regional markets where there was a lot of liquidity.

“Bond yields are currently very low and it is also expensive to invest in bonds. Thus, equities continue to be the preferred instrument at this point of time.

“It is not surprising that the market is going up but it has to do with more than just the expected elections this year,” Yong said.

Investors are moving back into their positions in the market after easing off in the last one month and they are accumulating stocks again.

“Foreign money has been coming in since middle of last year but it is not really huge in terms of large inflows. Certainly, there has been foreign buying but it is more from local investors,” Yong said, adding that commodities-related stocks were favoured by these funds.

It is not easy to judge whether the stock market momentum is sustainable but Yong believes it will sustain in the short term. However, the market is expected to be fairly volatile this year.

On the market risks, Yong pointed out that interest rates were expected to rise later this year and this could affect sentiment.

“Investors expect to see between 15% and 20% growth in corporate earnings in Asia this year. If the growth is not seen in the coming months, market confidence may be affected,” Yong said.

http://biz.thestar.com.my/news/story.asp?file=/2011/1/5/business/7735611&sec=business

Types of Investors

There are different styles and types of investors that exist in the stock market. Investors use the stock market to build their investment portfolio so that they can see a long term profit that takes place over a long period of time.

Someone who is just using the stock market to make money quickly for a short period of time is called a "trader". Members of an investment group fall into the first category: they are in the investment market for the long haul.

There are different types of investors that use different methods to analyze the market and the market conditions.

These three methods of analyzing the market are:


1. Technical analysis . This method of analysis is used by a "momentum" investor. Technical analysis looks at the price fluctuations that occur in the stock market. The investor bases the decision to buy or sell on what he feels the price will do next.


2. Fundamental analysis #1 . Fundamental analysis is used by the "growth" investor. This type of analysis decides if a certain company is a good investment based on the earnings of the company, growth sales, and margins of profit.

3. Fundamental analysis #2. A "value" investor uses this type of analysis. This method of analysis is similar to the analysis that a growth investor uses but is slightly different. A value investor takes a close look at those companies in the stock market that have a low value. The investor looks at stocks that are currently cheap and low but that have the potential to make a good comeback.

Most stock investment clubs use the fundamental method of analysis to make most of their investing decisions.

They find companies that are listed on the stock market that show good growth, profit, and earnings but that are still cheap to buy and haven’t yet reached their potential.

Members of the investment club buy this stock and hold on to it for several years so long as the fundamentals, as listed previously, continue to hold strong. This type of investment strategy is called "buy and hold".

http://www.investmentclubhelp.com/Types_of_Investors.html

Why day trade when you can capture a few big moves like this?

http://www.stressfreetrading.com/index2.html

Investing Styles: Value, Growth and Momentum Investing

Sideway Trends

When the price of an asset, e.g. a stock moves sideways, it is difficult to trade on momentum and apply the trend-following techniques because a trend reverses shortly after it is established.

Once a sideways trend is identified, one can profit by investing long or short once a stock price touches the lower or upper trend line.

(Another strategy is also to write/sell options to collect premiums.)

Sideways trends can persist for a long time.  Nevertheless, it is also important to know how to stop such a short-term trading technique when longer-term trends return.

Those with long-term goals may or may not wish to incorporate the above short-term trading techniques for a small portion of their selected good quality stocks which are in obvious sideway trends.  However, always remember to buy low, that is, at prices that are closer to the lower price boundary.

Certain stocks can go up more than 50% within a few hours to days.

We all know that in the stock market is always possible to watch certain stocks go up more than 50% within a few hours to days. This is especially true in the 4th quarter of the year where the buying frenzy starts in wall street.

The financial media constantly reports about momentum stocks that are achieving tremendous gains during the same day. And even when you can see online investors that make $3000 on a single trade, it is also not unusual to watch beginner stock investors lose a great deal of money because of a series of unwise decisions

The problem is that if you don’t know how to pick among stocks & how to properly approach them you could end up wasting dollars instead of making your wallet happy. You can’t just trade stocks like if you where gambling in Vegas or Atlantic City.

http://www.nanothailand.org/stock-trading/how-to-buy-and-sell-stocks-in-2009-stock-market-basics-trading-shares-online-2

Basic Steps on How to Find Profitable High Performance Stocks

Basic Steps on How to Find Profitable High Performance Stocks
March 2, 2010

Stock picking can be a extremely perplexing procedure and investors have very different ideas on how to achieve the desired outcome. Nevertheless, it may be very wise to follow some basic steps which will assist you to minimize the risk of the investments that you end up choosing.

This article will outline some basic steps for picking those high performance stocks that we all aspire to find.

You must have firmly placed in your mind exactly the time frame and the general strategy of the stock. This step is very important because it will influence as to the type of stocks you buy.

We shall presume that you have decided to be a long term investor. Therefore you would then be wanting to locate stocks that possess sustainable,good competitive advantages along with stable or increasing growth for the future.

The way to locating these High Performance stocks is by considering the historical performance of each stock over the past couple of years.Once you have found a likely stock you would then need to do a simple business S.W.O.T.analysis on the company. Swot basically means: Strength-Weakness-Opportunity-Threat.)

If you have decided instead to become a short term investor, it might be a good idea to a stick to one of the following couple of strategies:

1. Momentum Trading.

This useful strategy is to keep an eye open for stocks that have increased in both price and volume over the recent days trading or two. You would most likely find that momentum fluctuates rapidly to begin with and tends to lessen off as traders lose interest. Mind you nothing is guaranteed particularly in today’s market place

Usually most technical analysis will support this trading strategy. But my advice on this strategy is to look only for stocks that have exhibited stable and consistent rises in their share price. We are presuming that the idea is that when the stocks are not so volatile, we can merely ride the up-trend until the trend breaks.

2. Contrarian Strategy.

This second useful strategy is to be on the look for over-reactions that occur in the stock market from time to time. Past research has shown that the stock market is not always efficient as we are led to believe. This basically means that share prices do not always accurately reflect the true value of the stocks. This can be used very much to our advantage.

Take for example when a company has just recently announced bad news,like a predicted downturn in future profit.This is exactly is what is happening here and now. All you have to do is follow the daily stock market news to see this occurring.

Trades who trade with their emotions become disillusioned, become fearful, then panic and sell. As so often happens the share price often drops below the stocks actual fair value.

But before you decide whether to purchase the stock which has over-reacted to a bad news announcement, you should always take into consideration the possibility of recovery from the impact of the bad news.

For example, if the stock price had dropped by 20% after the company had just lost a legal case, but no permanent damage to the either the business’s reputation or the product had occurred, you can then be realistically confident that the market over-reacted. And given time the share price would no doubt rise again to its former level thereby rewarding you with a comfortable profit.

It would be prudent on using this strategy to find a list of stocks that have suffered a recent drop in share prices You could then analyze the potentiality of a reversal occurring by utilizing the well known technical indicator of candlestick analysis).

If the charts did confirm candlestick reversal patterns in the stocks in question, It would then be advisable to look through the recent news to analyze the exact causes of the recent price drops to ascertain that the over-sold opportunities actually existence.

Always do researches that will give you a choice of stocks that fits into to your own personal investment time frames and strategies. It is pointless trading in something you are not happy with or unsure of.

Once you have compiled a list of stocks to possibly purchase in the future, you would then need to diversify them in such a way that gives you the greatest reward/risk ratio. One way of achieving this is to employ a Markowitz analysis for your portfolio. This analysis will give you the exact proportions of money you should then apportion to each stock.

Hopefully these basic steps will get you started in your continuous quest to consistently make good profits in the stock market. Plus they will also broaden your knowledge about how the financial markets perform and react. Ultimately it will provide you with a sense of confidence that will enable you to make better trading decisions and therefore greater profits.

I wish happy profitable trading.

Author: Chris Strudwick
Source: ezinearticles.com
http://sellingstock.getherb.com/tag/stock-picking/

Stock Market Strategy: "One-day trade, Swing trade or Long-term trade"

Stock Market Strategy
Stock market is a risky place to make a profit.

Who are these players generating all this trade -speculating or investing - in the stock market?

There are many types of trades in the stock market.  However, essentially the three most popular of them are:

1.  One-day trade

2.  Swing trade

3.  Long-time trade.

It is common to think that the swing trade has a time horizon between the one-day trade and the long-time trade.  The time horizon of a swing trade is dependent on the event(s) influencing the player to terminate the trade.

The more astute would notice that all these types are characterized by a single factor (risk tolerance profile) of the players:  their ability to hold onto their position in the stock market for various investing time frames.


The beauty of the stock market is that it can be used for various purposes by different investors.


http://www.assetinvesting.com/?p=4473

Be careful when playing momentum – the trend may appear to be your friend, but can quickly turn into a foe

Momentum – The trend is not always your friend

Posted by indianmutualfund

Have you ever thought why most stock tips you receive are about buying a stock that has done well recently, a recent winner? Are your brokers and friends great stock pickers who pick stocks that do well, or is it just momentum – picking stocks AFTER they have done well – at work? With no offense to anybody’s skills, it’s probably the latter.

Momentum is India’s favourite market strategy. Most stock picks and market recommendations, whether they come from a broker’s desk or a cocktail party, when looked at in any detail, point to momentum. What does that mean? Quite simply, it means betting on things that have done well recently – whether it is an individual stock, a particular sector or the market as a whole. A classic recent example – everyone wants to buy steel stocks because they have done well, everyone wants to sell telecom stocks because they have done badly. Buy winners, sell losers, it’s as simple as that.

Indians are not the only ones who understand or love momentum, and there is no magic behind it. Momentum is a time-tested globally known investment strategy with its roots in behavioural finance. When good news comes out, people under react because they are not sure, and the stock price doesn’t rise enough. The stock has room to go, and as more good news comes out, people overreact, driving the stock price up further. Similarly, on the downside, as bad news comes out, people over react to bad news, and in despair run for an exit, leading to a further correction. The tendency to overreact to bad news and under react to good news is timeless and inherent in human nature, and as long as it works, momentum trading will continue to work.

In fact, momentum has historically been even more powerful in India, than other global markets, and is one of the best performing strategies over the last 15 years. The most basic indicators have made for very favourable trading strategies. What makes it even more popular is that momentum is one of the easiest things to do – it takes very little to get the past prices of stocks and figure out which ones are doing well. You don’t need to know anything about the stock or the business to trade momentum – you could be following the price of bananas for all it matters.

Moreover, for a broker or an individual, momentum is a professional and socially safe strategy. You’re always following the trend, always selling what is doing well, and that’s a pretty easy sale to make. You always sound right, and who doesn’t like that? Compare this to value investing – after all the work involved in understanding a company’s inherent value and financials, you are the one rooting for an undervalued firm whose stock price has been beaten down. Even tougher, you’re running down a company that has done well because it is overvalued, even though everyone else loves it. It’s a pretty unpopular place to be in and a tough sale to make to a client.

Unfortunately, for all its ease and apparent money making abilities, momentum can revert pretty quickly, and when it does, it gets ugly. No trend sustains itself forever, definitely not in the short to medium term, and when a trend reverts, it is painful being a momentum trader. Think of 2007. For the three year bull run, markets were doing well, and every trader was bullish – momentum did well and every investor felt they had discovered a gold mine…until 2008 struck. The upward trend reverted, the market crashed and momentum crashed with it, and quickly. Momentum traders saw gains made over three years quickly erode as markets took a turn.

My favourite story about the dangers of playing momentum is Religare AGILE, a mutual fund that claimed to be a quant fund, but is actually just playing momentum. AGILE launched when the tide just turned and momentum was having its worse run. In a year when the markets were down 60%, AGILE bled much more. A period of downward momentum followed and AGILE did fine, but come May 2009, the downward trend reverted. The markets rallied nearly 90%, momentum strategies suffered, and AGILE returned less than 50%. AGILE’s poor performance, incidentally, has nothing to do with being a quant fund – many quants have done well over this period – it is simply playing momentum.

Cut to the last quarter of 2009 – another great period for momentum as the markets have had an upward trend, and to no surprise, AGILE has done superbly, as have other funds that have played the same trick. What will happen to them when the trend reverts, however, is the question?

Should you not play momentum or invest in a momentum fund? In general, yes, investing in a concentrated strategy is a bad idea – investments should be diversified across investment styles. If you do have to play momentum, do it in a conservative way with moderate risk. Most of all don’t be fooled by a manager’s great returns over a period – he may just be playing momentum. Check out his returns when the trend reverts.

Be careful when playing momentum – following the trend may appear to be your friend, but can quickly turn into a foe you had never bargained for.

Source: http://www.moneycontrol.com/news/mf-experts/momentum-–-the-trend-is-not-always-your-friend_438780.html

****3 Steps To Profitable Stock Picking

3 Steps To Profitable Stock Picking

Stock picking is a very complicated process and investors have different approaches. However, it is wise to follow general steps to minimize the risk of the investments. This article will outline these basic steps for picking high performance stocks.

Step 1. Decide on the time frame and the general strategy of the investment. This step is very important because it will dictate the type of stocks you buy.

Suppose you decide to be a long term investor, you would want to find stocks that have sustainable competitive advantages along with stable growth. The key for finding these stocks is by looking at the historical performance of each stock over the past decades and do a simple business S.W.O.T. (Strength-weakness-opportunity-threat) analysis on the company.

If you decide to be a short term investor, you would like to adhere to one of the following strategies:

a. Momentum Trading. This strategy is to look for stocks that increase in both price and volume over the recent past. Most technical analyses support this trading strategy. My advice on this strategy is to look for stocks that have demonstrated stable and smooth rises in their prices. The idea is that when the stocks are not volatile, you can simply ride the up-trend until the trend breaks.

b. Contrarian Strategy. This strategy is to look for over-reactions in the stock market. Researches show that stock market is not always efficient, which means prices do not always accurately represent the values of the stocks. When a company announces a bad news, people panic and price often drops below the stock's fair value. To decide whether a stock over-reacted to a news, you should look at the possibility of recovery from the impact of the bad news. For example, if the stock drops 20% after the company loses a legal case that has no permanent damage to the business's brand and product, you can be confident that the market over-reacted. My advice on this strategy is to find a list of stocks that have recent drops in prices, analyze the potential for a reversal (through candlestick analysis). If the stocks demonstrate candlestick reversal patterns, I will go through the recent news to analyze the causes of the recent price drops to determine the existence of over-sold opportunities.

Step 2. Conduct researches that give you a selection of stocks that is consistent to your investment time frame and strategy. There are numerous stock screeners on the web that can help you find stocks according to your needs.

Step 3. Once you have a list of stocks to buy, you would need to diversify them in a way that gives the greatest reward/risk ratio. One way to do this is conduct a Markowitz analysis for your portfolio. The analysis will give you the proportions of money you should allocate to each stock. This step is crucial because diversification is one of the free-lunches in the investment world.

These three steps should get you started in your quest to consistently make money in the stock market. They will deepen your knowledge about the financial markets, and would provide a of confidence that helps you to make better trading decisions.

http://tradingindicator.blogspot.com/2010/01/3-steps-to-profitable-stock-picking.html

Comment:  There are many ways to make money.  Investing for the long term is profitable for many investors.  Some of those who employ other strategies can also be profitable too.