I recently stumbled upon an old research paper on momentum investing. The subject was whether it was a strategy worth pursuing. And it was a great reminder of just how powerful a momentum investing strategy — like the one my Maximum Profit subscribers use — can be.

One of the most interesting things about this research paper was the time period.

It involved an extensive backtest done over a 22-year period between 1983 and 2004. And its coverage included 18,000+ stocks.

This was during a time when momentum investing in stocks was ridiculed by the experts on Wall Street. Darn near witchcraft, like I mentioned above. I specifically mention stocks because momentum investing or trend following had already been successful among commodity and futures traders. But nearly no one who invested in stocks at the time would touch trend following or technical analysis with a 10-foot pole.

The point of this research was to see if it could work in stocks… despite the stigma surrounding the strategy. The headline of the research paper was appropriately named “Does Trend Following Work on Stocks?”

The other interesting thing about this period is that it’s eerily similar to the one we’ve just gone through. Many in the financial world have pointed out the similarities between now and back then.

For instance, back then, the roaring 90s bull market led to the dot com bubble, which was the collapse of internet stocks. We recently wrapped up the longest bull market in history (2009 – 2020) that saw tech stocks go on a vicious climb near the end of the bull market, only to collapse in spectacular fashion.

Now with all that said, let’s take a look at the results…

The Results…

The criteria for the backtest was to buy a stock when it had hit a new high. They even accounted for commissions in their test. Remember those things?

They used a trailing stop loss as their exit. Their trailing stop loss method was a bit more complicated than ours. We use a standard trailing stop loss, whether it’s 12%, 15%, or 20%. They based their stop loss on the volatility of the stock in question. So, for less volatile stocks (think utility companies), the trailing stop loss was tighter than, say, a small-cap stock that saw wild swings where the stop loss might be as much as 50%.

But amongst all their trades, their average trailing stop loss was 27%. Regardless of the exact stop loss, the point is to have a hard-defined exit (preserve capital).

Here’s the distribution chart showing the results from their backtest:

Here are a few key takeaways.

• The average trade made 15.2%.
• The average days in a trade were 305 days.
• The winning percentage was 49.3%.

Now, a 15.2% average return might not sound fantastic. But remember, this was just a basic backtest to see if momentum investing works with stocks. Once you consider the time period and how many stocks were in the backtest (18,000+ trades), it’s pretty impressive.

At the end of the day, this test provided a great foundation for future momentum strategies. And more importantly, it revealed that momentum investing works.

Closing Thoughts

Today, momentum investing isn’t the red-headed stepchild it once was. Several hedge funds and investment firms have some sort of momentum investing strategy. Even BlackRock, Invesco, and Vanguard have momentum ETFs and/or mutual funds.

A lot of research has been done in the momentum space since the study above. And they’ve all come to the same conclusion… it works.

I want to leave you with this… if we want to beat the market, we need to own stocks that are gaining more than average. Whether you follow our exact strategy over at Maximum Profit or not, what you need to be able to do is simple:

Identify which stocks are currently performing the best and are likely to continue performing the best. Buy high and sell higher.

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