Using the I-System we can also develop Momentum Strategy portfolios. Momentum strategy is a variant of trend following. It entails buying best-performing stocks and can also include short-selling the worst-performing ones.

Researchers from the London Business School, Elroy Dimson, Paul Marsh and Mike Staunton analyzed nearly 110 years’ of stock market price history starting from 1900. They constructed investment portfolios by selecting 20 top performing stocks in the previous 12 months from among UK’s 100 largest publicly trading firms, and compared their performance to portfolios of 20 worst performers, re-calculating the portfolios every month. Their results are illustrated below:

Portfolios constructed with previous year’s lowest-performing stocks would have turned £1 invested in 1900 into £49 by 2009. By contrast, previous year’s top-performing quintile of stocks would have turned £1 into £2.3 million[1], which reflects a 10.3% difference in compound annual rate of return.

The above figures correspond to the outcome at the end of 2009, following the 2008 market crash. At the close of 2007, the figures were even more impressive: the portfolio of winners generated a compound annual rate of return of 15.2%, turning £1 invested in 1900 into more than £4.2 million.

The gap between investing in best and worst performing stocks was even wider when data from the entire London stock market was taken into account. From 1955 onward, the portfolio of previous year’s top performers generated a compound annual rate of return of 18.3% against the return of 6.8% for the portfolio of worst performing stocks.

These results were “striking and remarkably persistent” across 17 out of 18 global markets studied with data going back to 1926 for America and to 1975 for larger European markets (the sole exception was Japan, where results were based on post-2000 data).[1]

A hybrid momentum/trend following strategy can be developed where we buy stocks of companies whose share price begins trending up, and sell short those whose shares begin to trend down. Developing a successful momentum portfolio could be more involved than with other portfolio solutions listed here, but the performance merits of this strategy could make the effort worthwhile.

[1]Financial Times, “Momentum effect gains new admirers” by Steve Johnson, 23 January 2011