52-Week high and momentum investing

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Link to the research paper  by Thomas George and Chuan-Yang Hwang.

Here is the Abstract:

ABSTRACT

“When coupled with a stock’s current price, a readily available piece of information—the
52-week high price–explains a large portion of the profits from momentum investing.
Nearness to the 52-week high dominates and improves upon the forecasting power of
past returns (both individual and industry returns) for future returns. Future returns
forecast using the 52-week high do not reverse in the long run. These results indicate
that short-term momentum and long-term reversals are largely separate phenomena,
which presents a challenge to current theory that models these aspects of security
returns as integrated components of the market’s response to news.”

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Some notes:

The 52-Week High and Momentum Investing Notes

Jegadeesh and Titman showed that a strategy that buys the top 10% and sells the bottom 10% ranked by 6-month returns and holds for six months produces profits of 1% per month. Others have documented long term reversals in stocks. Poorly performing stocks in the past will do better than outperforming stocks over a 3-5 year period. These are two different phenomena.

The 52-week high explains a lot of the profits from momentum investing. Traders are slow to react to good news. Nearness to a 52-week high outperforms a strategy based on past returns.

When stocks are close to the 52-week high, traders do not want to push the price higher even in the face of positive information that would justify the new high. Eventually information will move the price to a new high.

This might have to do with anchoring bias.

January has a negative effect on the 52-week and the momentum strategies.

The paper looked at three momentum strategies. They were:

  1. Long (short) position in 30% of top (bottom) performing stocks.
  2. Use industry returns. Long (short) position in stocks within the 30% of the top (bottom) performing industries.
  3. How close the current price is to the 52-week high. Long (short) based on how close (far) the stock is from the 52-week high.

The 52-week high strategy outperformed and the outperformance was even greater when excluding January.

http://basehitinvesting.com/wp-content/uploads/2013/01/52-Week-High-and-Momentum-Investing.pdf