Stop the 'Momentum' Abuse

What pundits write off as 'momentum' is, more often than not, quantifiable

Dec 9, 2014 at 8:52 AM
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Momentum -- the concept is very real. Plenty of day traders and investors incorporate it into their strategies. But it's a word that often gets misapplied and misused. Ever watch a football game and hear the announcers say the word "momentum"?

OK, that's a trick question. It's impossible to watch a game without hearing "momentum" spit out. Unfortunately, it's used incorrectly about 99.9% of the time. And yes, it drives me nuts.

When a team makes a good play, perhaps a score or an interception, the announcer inevitably cites momentum. And yes, they have improved their chances of winning via the play. But it has nothing to do with any sort of extra motivation, concentration or whatever intangible and immeasurable factor they consider some sort of byproduct of said momentum. It's the impact of the play itself that has changed the odds of the outcome.

Case in point -- the Ravens are leading the Dolphins 14-13 with 8:25 remaining in the game, and they have the ball on the Dolphins' two-yard line. On second down, Joe Flacco goes back to pass, gets hit, and appears to have fumbled. The Dolphins recover. But alas, replays show he was in the act of passing, and the play is (correctly) overturned. It's Ravens ball, third and goal from the 10, instead of Dolphins ball, first and 10 on their own five.

The announcer says, "The Dolphins missed their chance to seize momentum" -- or something to that effect. Nooooooo!!!!!!

They missed their chance to make a play that would have dramatically tilted the odds. Or, more accurately, a play that appeared to dramatically tilt the odds wasn't as it appeared.

I plugged in the before and after the replay into the Win Probability Calculator at Advanced Football Analytics. Had the Dolphins gotten the ball, here's how their numbers looked.

Win Probability Calculator Dolphins vs. Ravens

They had -0.21 expected points (that is, the Ravens were still expected to score the next 0.21 points) and a win probability of 41%. But the call gets overturned. So here are the ensuing numbers from the Ravens' perspective.

Win Probability Calculator Dolphins vs. Ravens

The Ravens are expected to get the next 4.93 points, and more importantly, have an 82% win probability. So, the replay resulted in a 4.71-point increase in the Ravens' expected points, and a 23% addition (really, lack of subtraction) from their win probability. That's not "momentum" -- these are tangible numbers.

Thanks for letting me vent. Fortunately, in the financial world, we tend towards better use of the concept.

I've never gone full-tilt into momentum investing or trading, but I believe in the basic tenets. Strength can beget strength, weakness can beget weakness. We see it in CBOE Volatility Index (VIX) all the time. Lifts often are self-fulfilling and lead to greater lifts as traders get squeezed and are forced to take action, via trading with the trend, in order to defend a position.

Remember "pinning"? That's the term for when a stock closes at or near a strike price on expiration. I don't track them anymore mainly because there are strikes every dollar (or less) now, and expirations every week (or less). Everything pins!

But pinning (or abject avoidance thereof) was literally a function of momentum (or lack thereof). If a strike has a large open interest and a stock has little volatility, traders with long options positions around the strike need to hedge -- or lose the value of their dwindling investment. So they would initiate transactions that served to drive the stock towards that strike, which would induce pain in the next long options traders, causing him to initiate a similar transaction and, yada yada yada, momentum towards strike.

Conversely, a volatile stock might squeeze options shorts into defending their positions via transactions that serve to drive the stock away from the strike, inducing the same pain-action cycle as above -- just in reverse, and with open-ended losses staring traders in the face absent any action. Ergo, self-fulfilling momentum away from strike.

So yes, momentum is tough to quantify, but it exists -- just not in the tail-wags-dog form of "analysis" you see in a typical football game.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

 

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