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Why momentum works

Overconfident investors might help explain why momentum investing works
Why momentum works

Perhaps the strongest deviation from the simplest textbook theory of market efficiency is the success of momentum investing. For example, my no-thought momentum portfolio (comprising the 20 biggest rising stocks in the previous 12 months) has outperformed the FTSE 350 by 9.1 percentage points a year over the last 10 years. This, of course, is no mere quirk. Good returns on momentum strategies were first spotted in US stocks by Sheridan Titman and Narasimhan Jegadeesh in 2001 and since then have been discovered in international markets as well as in commodities and currencies.

The success of momentum investing is therefore as robust a finding as we’re likely to get in noisy financial data. But why does it exist?

Professor Titman has a new theory: it’s a result of investors’ overconfidence.

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