Resource Library

Return to Buying Winners and Selling Losers: Implications for Stock Market Efficiency
Jegadeesh and Titman are the first to rigorously measure the momentum effect in the stock market. The analysed the returns of all stocks listed on the New York Stock Exchange and the American Stock Exchange over 20 years and found that strategies that buy stocks that have performed well and sell stocks that have performed poorly in the past year generate significant positive returns over 3 to 12 month holding periods. Following the publication of their article, other researchers (see Rouwenhorst in Europe and Cleary and Inglis in Canada, among others) have shown that the momentum effect exists in almost all markets.

International Momentum Strategies
Rouwenhorst shows that the momentum effect exists on European markets and that, from 1980 to 1995, an internationally diversified portfolio of past winners outperformed a portfolio of past losers by about 1% per month.

Momentum in Canadian Stock Returns
The authors conclude that momentum trading may have merit for more flexible traders facing lower transaction costs.

Are Investors Reluctant to Realize Their Losses?
In this study, Terrance Odean tests the tendency of investors to hold losing investments too long and sell winning investments too soon, by analyzing trading records for 10,000 accounts at a large discount brokerage house. These investors demonstrate a strong preference for realizing winners rather than losers. This is what is known as the « disposition effect ».

Does Disposition Drive Momentum?
Investors are subject to the Ç disposition effect È: they tend to hold loosing stocks too long and sell winners too soon.

In this study, the authors test the hypothesis that the disposition effect drives stock price momentum. The disposition effect should cause investors to under react to negative news on a losing stock. That should delay the impact of the news on the stock, which will only gradually decline, causing downward momentum. Similarly, investors will tend to sell too soon when good news comes out on a winning stock. That will again delay the impact of the news on the stock, which will rise only gradually, causing upward momentum.

Using data from a large Shanghai brokerage firm, the authors analyze a sample of more than 13,000 investors and firms. They conclude that a large majority of investors exhibit a disposition effect. They also conclude that the disposition does drive momentum.

The Disposition Effect and Underreaction to News
In this paper, Frazzini shows that the “disposition effect,” that is the tendency of investors to ride losses and realize gains, induces “underreaction” to news, leading to return predictability. She uses data on mutual fund holdings to construct a new measure of reference purchasing prices for individual stocks, and she shows that post-announcement price drift is most severe whenever capital gains and the news event have the same sign. The magnitude of the drift depends on the capital gains (losses) experienced by the stock holders on the announcement date. An event-driven strategy based on this effect yields monthly excess returns of over 2%.

Cognitive Biases Series
In this series of 6 articles, Meir Statman explains the principal cognitive biases exhibited by investors that have a negative impact on their portfolio returns:

• Availability bias
• Anchoring bias
• Confirmation bias
• Hindsight bias
• Mental accounting bias
• Fairness bias

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