Adding an Acceleration Factor to Momentum Investing

In a post on the CFA Institute’s Enterprising Investor blog, Joachim Klement of the CFA Institute Research Foundation highlights research suggesting that “one can improve the results of traditional momentum investing by looking at momentum acceleration.” Klement expresses some skepticism regarding momentum investing – “why should prices go up just because they have gone up in the past?” – and notes the risk of “momentum crashes.” Nonetheless, he notes that Cliff Asness and others have pointed out that the “momentum effect has persisted for more than 200 years, exists across many different asset classes, and can be profitably exploited by almost every investor.” According to Klement, “there is plenty of evidence that momentum investing works in the medium term,” meaning that “winning investments of the last three to 12 months tend to outperform in the subsequent months.” His main focus in the post, however, is the “forefront of current research,” including work by Moringstar and by Didier Sornette at ETH Zurich, which suggests that “a simple measure of past change in momentum . . .can predict future performance.” Specifically, “stocks with the highest acceleration . . . tend to have higher returns in the future than stocks with lower acceleration.” The idea is “to identify trends right when they take off” and when “the influx of fresh investors abates and the trend decelerates again”  — i.e., “to invest in a trend early and get out before it is too late.” While noting that such research is “still in its infancy,” Klement expresses optimism that “the acceleration factor may not only be used to improve the results of traditional momentum strategies, but may predict future . . . market declines or even crashes.”