Momentum Trading: The New Alchemy
Posted: 24 Oct 2016 Last revised: 18 Sep 2020
Date Written: August 8, 2000
Abstract
Momentum traders buy stock (often on margin) as prices rise and sell as prices fall. In essence, they are trying to obtain the benefits of a call option — upside participation with limited risk on the downside — without any payment of an option premium. The strategy appears to offer a chance of huge gains with little risk and minimal cost, but its real risks and costs become known only when it's too late — after the strategy has failed, and taken markets down with it.
Keywords: Momentum Trading, Momentum Investing, Tech-Stock Bubble, Internet Bubble, Option Pricing Theory, Black-Scholes-Merton, Option Replication, Call Options, Leverage, Margin Calls, Portfolio Insurance, 1987 Market Crash, Long-Term Capital Management, LTCM, Active Extension, Enhanced Active Equity
JEL Classification: G10, G13
Suggested Citation: Suggested Citation