“Momentum is clearly based on behavioral explanations, including herding, anchoring, confirmation bias and the disposition effect. Because momentum has performed well historically, it’s clear that these behavioral biases have likely existed for a long time. And human behaviors tend to persist even after the biases are discovered and made well known. After all, that’s what makes us human.”
The above quote is from this article by Larry Swedroe, director of research for The BAM Alliance and frequent contributor to ETF.com
When evaluating a systematic strategy and performing due diligence on methodology, one of the most important questions to ask yourself is, is this system sustainable and why? The above quote is an extremely powerful explanation of why exposure to the momentum factor has worked and will continue to work. However, nothing works all the time and although momentum looks really good when it’s in favor it looks equally bad when it’s out of favor. The way to minimize that underperformance is to develop a system that mitigates that risk.
Below is an interesting chart from the same article and shows Odds of Underperformance (%) for six leading factors: