Implicit Momentum Bias

Tadas asked an interesting question in his recent post: Where did all the finance bloggers go? A variety of folks gave thoughtful replies: Josh Brown, Flex Salmon, David Merkel, Scott Bell, the Macro Men, and bunch of anonymous professional traders. Undoubtedly, there is truth in all their observations.

Yet, perhaps there is a common root cause at work, not yet stated: implicit momentum bias.

Let me break that down, as there is a bit of intentional double entendre. By “momentum”, I intend a sustained trend, whether conceptual or technical. By “implicit bias”, I intend a cognitive preference which is rarely stated and often partially or fully unconscious.

You can see this bias in numerous ways, affecting both blog readers and authors:

• Retail trading: the vast majority of retail investors and traders are pursuing discretionary strategies which boil down to technical momentum, whether conceived explicitly (e.g. ad hoc moving average strategies or more arcane technical analysis voodoo) or implicitly (e.g. cocktail party stock tips or watching CNBC). Thus, the vast majority of retail exhibit this bias.
• Asset managers: many active asset managers are pursuing strategies which also essentially boil down to technical momentum, either due to stock picking or executing strategies aligned with historically strong long-term risk-adjusted returns of momentum. This is exemplified by a quick scan of the Top Papers from SSRN, for which 2 of 10 top are momentum papers (followed by lots more of varying sophistication). Thus, majority of asset managers exhibit this bias.
• Quant funds: many low-, and medium-frequency funds run strategies which are essentially momentum dressed in sophisticated clothing, often tracking one or more risk premia (whether due to anomalies or market structure) rather than raw prices. This is nicely exemplified by Ilmanen’s well-reviewed Expected Returns, who now works at AQR. Thus, many hedge funds exhibit this bias.
• Mainstream financial media: ratings are driven by viewers’ perception “something is happening”, which almost always occurs in strongly trending markets: bubbles or crashes. In contrast, range-bound markets are often remarked to be “boring” or “frustrating”, with corresponding tanking in ratings. Thus, mainstream media exhibits this bias.
• Blogs / Twitter: building readership depends on establishing a distinctive perspective or “voice”, enabling a blog or stream to stand out amongst all the noise. This demands the corresponding content to be formulaic in some predictable sense. Blogs have an even higher bar than Twitter, as blogs are expected to hold up as being “good” despite hindsight bias—meaning their shelf life must extend until they are read at some indeterminate point in the future. Falkenblog is a good example, which has been a tireless advocate of the low-vol anomaly for many years. Thus, many blogs and twitter exhibit this bias.
• Alpha research: much of the search for alpha is tested via historical backtests that span many years, invariably including both trending and range-bound regimes. Invariably, majority of both alpha and beta strategies perform best in momentum-driven trending markets, of which the past 30 years have mostly been; those strategies that perform well in range markets often are regime-aware, and trade different across regimes. Careful review of nearly all popular tactical and dynamic asset allocation strategies exhibit this (along with many exhibiting a pervasive, unstated bias from the 30-year bond bull run). Thus, alpha research often exhibits this bias.

Momentum originates from one of the most influential aspects of human psychology: confirmation bias. Simply put, humans “like to be right”: enjoying and finding comfort in writing and reading information that confirms their existing beliefs or hypotheses (scientifically attributable to stimulus-response dopamine effects).

Thus, range-bound markets are frustrating for many folks because they form opinions conceived as directional bets. For them, their momentum bias generates significant pain in markets like this—which makes them tune-out. This is also seen in hedge funds, which in aggregate have a comparatively poor record in range-bound markets. In contrast, many computers find enjoyment in markets which generally defy non-quantitative directional prediction.

Coming full circle back to Tadas’ question, perhaps this implicit momentum bias partially explains the durability of his blog—and, in doing so, perhaps contributes to the question he raised. He astutely blends the benefits of momentum, while avoiding its detriments:

• Is a “forecast free blog”, thus ensuring he cannot be wrong in hindsight
• Follows a well-established presentation style, thus ensuring his distinctive voice
• Aggregates and synthesizes from materials authored by others, ensuring both a constant stream of material and diversity of opposing perspectives to satisfy both sides of any debate
• Varies topical coverage on a daily basis to remain relevant and responsive to the trends which dominate investor and trader mindshare

If only we could all replicate alpha strategies as durably as his blog has effectively contributed to the financial blogosphere over the years.