Momentum Factor
Momentum factor is an indicator used to measure asset price trends and market conditions. It is based on observations in the market and suggests that assets that have performed well in the past are likely to continue to perform well in the future, while assets that have performed poorly in the past may continue to perform poorly in the future. The momentum factor evaluates the momentum of an asset by calculating the rate of change in asset prices and trends in the time series.
Definition: The momentum factor is an indicator used to measure asset price trends and market conditions. It is based on the observation that assets that have performed well over a certain period are likely to continue performing well in the future, while assets that have performed poorly are likely to continue underperforming. The momentum factor evaluates an asset's momentum by calculating the rate of change in its price and the trend over a time series.
Origin: The concept of the momentum factor dates back to the early 20th century but was widely researched and applied in the 1990s. In 1993, Jegadeesh and Titman published a seminal paper that systematically studied the momentum effect, demonstrating that in the U.S. stock market, stocks that performed well in the past tend to continue performing well in the future.
Categories and Characteristics: The momentum factor can be divided into absolute momentum and relative momentum.
- Absolute Momentum: Refers to the momentum of a single asset based on its historical price. For example, if a stock has been rising in price over the past 12 months, it is considered to have positive absolute momentum.
- Relative Momentum: Refers to the relative performance between different assets. For example, among a group of stocks, those that have performed the best over the past 6 months are considered to have positive relative momentum.
- Trend Following: The momentum factor relies on price trends and is suitable for markets with clear trends.
- Time Sensitivity: The effectiveness of the momentum factor may change over time, requiring regular adjustments and re-evaluations.
Specific Cases:
- Case One: Suppose Investor A buys a group of the best-performing tech stocks over the past 12 months at the beginning of 2023 and sells them at the beginning of 2024. During this period, these tech stocks continue to perform well, and Investor A achieves significant returns. This is an application of the momentum factor in real investment.
- Case Two: Investor B uses a momentum strategy to trade in the forex market. He buys the strongest-performing currency pairs over the past 3 months and sells the weakest-performing ones. Through this strategy, Investor B achieves excess returns over a period.
Common Questions:
- Is the momentum factor always effective? The momentum factor is not always effective, especially in highly volatile or trendless markets, where momentum strategies may fail.
- How to choose the time window for the momentum factor? The choice of the time window for the momentum factor is crucial. Commonly used time windows are 3 months, 6 months, or 12 months, but the specific choice should be adjusted based on market conditions and investment strategies.
