Why Momentum Matters More in Trading than Football

Let me just take this opportunity, as your self-appointed "momentum" spotter, to highlight yet another case of "momentum" being used as an inaccurate shorthand for "the actual effect of plays on a football field."

About an hour and half before Dez Bryant's Immaculate Non-Reception, the Cowboys attempted a long field goal with about 30 seconds left in the half. It missed. The Packers then got quickly into range and hit their own field goal attempt. The Cowboys' lead went from (potentially) 17-7 to 14-10. And, of course, the announcers couched the turn of events in "what a change in momentum!" terms.

But here's the deal. According to the win probability calculator at AdvancedFootballAnalytics.com, that sequence of events dropped the Cowboys' win probability from 74% to 55%, by the simple virtue of a 10-point lead (that never happened) dropping to a 4-point lead. That considers nothing of the theoretical after-effects of the plays, just simply the difference between the two ... differentials.

So I just want to make myself clear: I do believe in the concept of momentum, just not in how it's defined ad nauseum by football announcers. The effect of a big play itself dwarfs any sort of "momentum" generated from the play.

In our trading/investing world, it's a bit different. I wrote recently on momentum as it pertains to stocks and indexes themselves. But a better example is how it affects our actual trading.

If you've ever traded actively, you know the feeling of how momentum -- or "timing," or "confidence" -- can come and go. Some days, you just feel it. It's intangible, but it's there. You like a stock or a future, and you get a nice entry price. You take half the position off an hour later, then buy it back profitably, and you're in a groove. The name backs and fills and rides an upwards channel and before you know it, you've had a terrific trading day.

Unfortunately, we've all sat on the other side of that sort of trade, too. You buy, it doesn't work, you stop yourself out for a loss near the bottom, you buy again -- and again, it goes against you. You swear off the name, and struggle to find a good entry in another name. Part of the struggle is because you've lost confidence and timing, thanks to the first couple of bad flips that are still bothering you. Or maybe you so want to erase the loss(es) that you lower your criteria a bit, and push into a trade with a mediocre setup.

There's also that trade you just miss. You had the right idea but it got away before you could get in. Instead of rolling as above, you're starting from scratch again.

And finally, there's the error. That winner you nailed out of the gate never actually happened. The stock "printed" in error ... or whatever. When I was a floor trader, brokers would sometimes come back a few minutes later and say they executed the wrong side and they'd like an "out." And since it's a guy you work with, you do him the favor. It's all fine and good, but maybe now you're on the hook for the hedge against that trade.

One of the first lessons I ever learned was to just close errors immediately, take the hit, and move onto the next trade. Why? Because timing as a trader is indeed that important. If you're still worried about getting whole on that last trade, you're missing the next one.

So yes, I very much believe in momentum -- just not the dumbed-down version we get fed every weekend. The most important aspect of a single trade could very well be the momentum/timing/confidence derived from that trade. The "booked" profit is nice, but unlike a football play, the after-effects may end up mattering more in the long run than the results of the play itself.

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