The day momentum died, mean-reversion was born. Now they have both merged into what I call momersion.
The other day I read an article about microscopic momentum where it was defined as follows:
“Multiply each return by the sign of the previous return, creating a new return for our ‘simplified momentum strategy’.”
Actually this is the quant way of doing things. The technical analysis way is as follows:
If close of today > close of yesterday then buy at the close
If close of today < close of yesterday then short at the close
This is how a technical analyst would backtest the result of applying a negation operator to the returns of a price series.
This is the backtest in S&P 500 from 1960, no commissions, one share per trade:
The day momentum died marked a paradigm shift in the stock market in many respects. No need to mention them, everyone knows. It was April 14, 2000, or around that time anyway.
The new paradigm was mean-reversion. In system form:
If close of today < close of yesterday then buy at the close
If close of today > close of yesterday then short at the close
This is the backtest of the mean-reversion strategy after the day momentum died:
The strategy worked well even during the 2000s uptrend and the 2008 plunge. Amazing, isn’t it?
But it could not work for long because quants identified it fast. On July 30, 2009 or around that time, mean-reversion died too. Call it an “arbitraged anomaly”, just like momentum.
So what do we have since? This is how mean-reversion has performed:
Momentum came back temporarily, offering hopes but then died again, just like a “dead cat bounce” and mean-reversion has reappeared since.
I call this new paradigm momersion: a little momentum followed by a little mean-reversion so that all those hit by at least 10 cognitive biases cannot make any money easily in the longer-term unless they put some real work to identify value and are also a little lucky.
As I have written before, one could see everything from this 1-lag, 250-day autocorrelation chart:
Self-explanatory if you do not suffer from the 10 cognitive biases I did not specifically mention.
Momersion will persist until everyone who has built a business on hindsight bias is out of the game. This is how the market works. Value seeking always prevails above and over naive schemes to extract alpha.
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