COMMENT
The Return Of Momentum Investing

Remember 'momentum investing' and 'relative strength? Back in the Nineties bull run, all you had to do was find the shares that had recorded the greatest gains -- and buy in. During the run-up to the tech peak, 100%-plus annual returns were up for grabs for those regularly switching into the fastest movers. 

The momentum technique now seems to be making a comeback. For instance, if you bought the best performing blue chips of 2003 at the start of 2004, you'd now be sitting on a 20% profit. Not a bad return in a year when the market increased by nearly 8%.

But along with many other stock-picking strategies, relative strength was a casualty of the bear market. Following up this article, here's how you'd have done in recent years by picking out the year's five best and worst FTSE 100 shares and holding on for the next twelve months:

There's little consistency. Despite what happened with the 2003 winners in 2004, the (admittedly limited) data indicates last year's leaders are just as likely to lose money as make money in 2005. The laggards are more likely to record gains as well. So much for the momentum advice of 'running your winners' and 'shorting your losers'!

For the record, the blue chip winners of 2004 were Cairn Energy (LSE: CNE), Corus (LSE: CS.), Reuters (LSE: RTR), mm02 (LSE: OOM) and Enterprise Inns (LSE: ETI). The losers were British Sky Broadcasting (LSE: BSY), Amvescap (LSE: AVZ), Rentokil Initial (LSE: RTO), AstraZeneca (LSE: AZN) and Compass (LSE: CPG).

So why has momentum investing provided rather erratic results? Well, the theory is that share price data contains long-term repeatable patterns. But those who think they see such statistical relationships are in fact fooled by randomness. There's no logical reason why a share should go up one year (or any other timescale for that matter) simply because it has already gone up. Share prices are affected by a whole host of reasons, not least what happens to the underlying company. 

So if you pick shares using relative strength, here's some simple advice: relying on companies whose underlying business is inherently stable and predictable will be far more rewarding than relying on share price data that appears the same way.

More: What People Forget About Stock Market Statistics