I tested a popular contrarian trading strategy in blog #50 using Shiller’s PE ratio and found it wanting. The flip side of contrarian is momentum trading, which involves buying stocks after they have risen and selling stocks after they have fallen. So, momentum is about “going with the flow”, instead of against it. Since the contrarian strategy doesn’t seem to deliver the goods, you may wonder whether momentum trading will do the trick. This blog will attempt to answer this question with data.
As before, my data is from Robert Shiller’s website and consists of (a) the price levels of the S&P 500 index from Jan 1881 through Dec 2017 and (b) the index’s cyclical-adjusted PE ratio (CAPE) computed from its constituent stocks.
I will present two versions of the momentum strategy: a basic version and a ‘crash proof’ version. I will call these versions, MOM1 and MOM2 respectively.