Saturday, April 14, 2012

Momentum Trading

I recently read an interesting article on momentum trading, and I was wondering how it jives with the EMH.  It left me wondering whether there was some degree of survivorship bias when it comes to momentum trading, as the people who trade going up can make some returns, while the people who get burned by guessing the turning point wrong eventually leave the market.

This kind of asymmetry would also create an environment where there's an incentive to bid-up increases in prices.  If the general belief is that upward prices will keep on going upward, one can make money through buying stocks that are rising in price.  However, when the music ends, the people who bought on the way up still have their money; the people who got burned on the way down are no longer in the market to be evaluated.  In a sense, there's a coordination problem for momentum trading.  While all companies would prefer to not bid up the price of a stock, they are almost "forced" to by the asymmetric arbitrage opportunities.  These seem to be interesting game theory dynamics in a possibly efficient market.

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