Tahira Tabassum

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Momentum investing is a trading method in which investors purchase rising stocks and sell them when they appear to have reached their top. The objective is to work with volatility by identifying purchasing opportunities in short-term uptrends and then selling when the securities lose momentum. The tendency to purchase stocks that have performed well in the past is a well-known investor behavior phenomenon. Scientific studies have been looking into momentum investing strategies for nearly three decades and have found consistent excess returns in a variety of financial markets. However, the trading strategies typically analyzed in such research are not accessible to individual investors due to short selling constraints, nor are they profitable due to high trading costs (Foltice & Langer, 2015). There are no existing empirical studies that document momentum trading strategies particularly in context of Bangladesh Stock market and do not provide any insight on how investors choose the time horizon that is used to compute the past stock returns. Therefore, it is important to identify the exact time period on which investors base their trading strategies and to investigate whether such a period is unique. The purpose of this study is to investigate whether momentum strategy works in terms of trading in the Dhaka Stock Exchange and provide a concrete suggestion for the investors.

For this study, 70 highest market cap stocks have been selected and ranked based on their size. Based on the median value of market capitalization, two groups of portfolios are formed: small stocks portfolio and big stocks portfolio. This study analyzes the stocks in five horizons based on cumulative momentum returns of 1 day, 1 week (5 trading days), 1 month (20 trading days), 3months (60 trading days) and 6months (120 trading days). The top 30%, middle 40%, and bottom 30% of the returns are defined as winners, neutral, and loser portfolios, respectively. After sorting, the intersections of size and momentum portfolios resulted in the formation of six portfolios, namely: small-loser (SL), small-neutral (SN), small-winner (SW), big-loser (BL), big-neutral (BN), and big-winner (BW). The WML factor can be obtained from the difference between the average returns on winner portfolios and the loser portfolios. The momentum factor (WML) introduced by Jagadeesh and Titman (1993) has been used to capture anomalies related to the momentum of stock returns (Fama & French, 2012). This study will provide the investors with two opinions- i) whether the momentum strategy is working on DSE and ii) if there is momentum, whether the high return portfolio return can beat the market. Seeing the Average WML pattern, the decision of momentum strategy is obtained and the investing decision has been made by analyzing the comparison of the annualized average of high momentum portfolio returns and annualized average market return of each holding period to see whether the high momentum portfolio can beat the market of the same period.

Holding Period

Average WML Factor

1 Day

17.98%

1 Week

1.99%

1 Month

-4.69%

3 Months

3.91%

6 Months

38.42%

Table 1: Annualized Average of WML for the Portfolio

The WML annualize average represents there are positive WML for 1day, 1week, 3months and 6months horizon and negative WML for 1month horizon. This means that stocks selected based on positive momentum strategy is generating superior returns for the winner portfolios with daily, weekly, monthly and 6months holding period while loser portfolios outperform winner portfolios in 1month holding period.

Period

DSEX Average Annualized Return

High Momentum Portfolio Average Annualized Return

1 Day

47.15%

86.17%

1 Week

46.45%

61.34%

1 Month

33.61%

37.84%

3 Months

41.98%

64.28%

6 Months

54.18%

113.50%

Table 2: DSEX Index vs High Momentum Portfolio

The table shows that the DSEX index has risen abnormally during the selected time period. In the last one and half year the market expanded from 3986 point to 6756 point which means the market increased around 69% during the period. It was a bullish market characterized by optimism, investor confidence, and expectations that strong results should continue for an extended period of time. The market's current bullish trend may be due to a stock market bubble in which investors have driven stock prices above their intrinsic values or a market correction following COVID-19 (Kenton, 2022), however, it is difficult to predict consistently when the trends in the market might change (Hayes, 2022).

 

 

Figure 1: High Momentum Portfolio vs DSEX Index Performance

The graphs in Figure 1 reflect that if an investor invests BDT 100 on both DSEX (orange line) and high momentum portfolio (blue line) with a holding period of 1 day, after 362 trading days, high momentum portfolio would have more than doubled to BDT 231.98 compared to BDT 167.47 of DSEX portfolio. Similar results have been found in all other time horizons where the high momentum portfolio is beating DSEX portfolios. As mentioned before, loser portfolios for 1 month holding period outperformed winner portfolios, yet winner portfolios in terms of momentum is still generating higher returns compared to DSEX, where high momentum portfolio index is at 148.98 compared to 144.46 for DSEX.

So, does high momentum portfolios beat the market? Yes, high momentum portfolios average return beat the DSEX index average returns in all time horizons as illustrated in Figure 1. Therefore, investors can follow momentum strategy for high market cap stocks in order to generate higher return than DSEX in all the selected horizons. However, investors should not follow this on a perpetuity basis as this strategy is working because of the market correction at the start and end of the covid period which could be the probable reason for this excessive high returns; both for high momentum portfolios and DSEX index. At the start of the pandemic period, the benchmark index, DSEX, dropped 279 points on March 9 just one day after Bangladesh reported three cases of Covid-19, marking the largest one-day drop since the index's inception in 2013 (Haque & Chowdhury , 2020). Bangladesh is the only country in the world where stock trading has remained closed for more than 3 months and soon after resuming the market, it faced a bull run. Post-covid reopening of Dhaka Stock Exchange saw the market go on a bearish run and one of the reasons is that most of the investors in Bangladesh are momentum-driven, so the index suffers when it needs to rise or fall (Habib, 2020). The numbers agree with this investor behavior where high momentum portfolios consistently produced superior returns compared to DSEX.

The capital market had a remarkable year in 2021. The Dhaka Stock Exchange (DSE) witnessed a return of more than 20 percent two years in a row. In fact, the DSE's 25.1 percent return in 2021 was one of the best in the world (Rashid, 2022). The performance of the stock market in the last year is mainly the result of the pandemic correction. Therefore, this study suggests that although the overall momentum strategy is working for the stock market in Bangladesh based on the pattern in the selected time horizon and the high momentum portfolio is excessively beating the index return in all cases, investors should not rely on the pattern on a perpetuity basis. However, for a short-term investment, by following this strategy, investors can produce higher returns in comparison DSEX index. 

References

Fama, E. F., & French, K. R. (2012, September). Size, value, and momentum in international stock returns. Journal of Financial Economics, 105(3), 457-472.

Foltice, B., & Langer, T. (2015, January ). Profitable Momentum Trading Strategies for Individual Investors. Financial Markets and Portfolio Management, 29(2), 85-113.

Habib, A. (2020). Why is Bangladesh’s stock market bearish when global stocks are on bull run? The Daily Star .

Haque , S., & Chowdhury , D. A. (2020). IMPACT OF COVID-19 IN BANGLADESH STOCK MARKET. Asian Finance & Banking Review, 4(2), 2.

Hayes, A. (2022, January 24). Bull Market . Retrieved from Investopedia : https://www.investopedia.com/terms/b/bullmarket.asp

Jegadeesh, N., & Titman, S. (1993, March). Returns to Buying Winners and Selling Losers: Implications for Stock Market. The Journal of Finance, 48(1), 65-91.

Kenton, W. (2022, April 03). Bubble . Retrieved from Investopedia : https://www.investopedia.com/terms/b/bubble.asp

Rashid, M. (2022). Bangladesh capital market: Looking back and forward. Dhaka: The Daily Star .