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Trend Salience, Investor Behaviors and Momentum Profitability

Last Updated on 10 February, 2024 by Rejaul Karim

The research paper “Trend Salience, Investor Behaviors and Momentum Profitability” by Gareth Hurst and Paul Docherty investigates the intriguing phenomenon of trend extrapolation in financial markets and its impact on investor behaviors.

While it remains contentious as to which trends will undergo extrapolation or mean reversion, the authors analyze whether investors are more likely to extrapolate trends they deem salient by considering an investment strategy that takes into account both the magnitude and strength of the trend.

The study finds that their trend salience-based investment strategy significantly outperforms traditional momentum strategies, alluding to the behavioral underpinnings of momentum and its resistance to the Carhart [1997] four-factor model.

Furthermore, the performance of the trend salience signal proves to be robust across various investment horizons and size-sorted portfolios but exhibits time variability, particularly underperforming momentum in “down” markets and high-volatility scenarios where identifying salient trends is challenging.

Abstract Of Paper

Trend extrapolation in financial markets has been well documented, however it is contentious as to which trends will be extrapolated or mean reverted. We examine whether investors are more likely to extrapolate trends that they perceive to be salient by examining an investment strategy that considers both the magnitude and the strength of the trend. Consistent with behavioral models of momentum, our investment strategy based on trend salience significantly outperforms traditional momentum strategies and is not explained by the Carhart [1997] four-factor model. The relative performance of the trend salience signal is robust across different investment horizons and size-sorted portfolios, although is time-varying; the strategy does not outperform momentum in “down” markets where volatility is high and salient trends are more difficult to identify.

Original paper – Download PDF

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Author

Gareth Hurst
University of Newcastle (Australia)

Paul Docherty
The Brattle Group

Conclusion

In conclusion, the research paper “Trend Salience, Investor Behaviors and Momentum Profitability” by Gareth Hurst and Paul Docherty offers valuable insights into the role of trend salience in financial markets.

By examining investment strategies focused on both the magnitude and strength of trends, the study reveals that investors are more likely to extrapolate trends they perceive as salient. Remarkably, this trend salience-based strategy outperforms traditional momentum strategies, aligning with behavioral models of momentum and defying the Carhart [1997] four-factor model.

Notably, the trend salience signal demonstrates robust performance across various investment horizons and size-sorted portfolios, albeit with time-varying effectiveness. In “down” markets characterized by high volatility, the strategy falters, struggling to outperform momentum as salient trends become harder to discern.

Hurst and Docherty’s work thus contributes to a deeper understanding of investor behaviors and the ramifications of trend salience in shaping momentum profitability.

Related Reading:

The Formation Process of Winners and Losers in Momentum Investing

The Acceleration Effect and Gamma Factor in Asset Pricing

FAQ

How does the trend salience-based investment strategy perform compared to traditional momentum strategies, and what does this reveal about the behavioral underpinnings of momentum?

The study finds that the trend salience-based investment strategy significantly outperforms traditional momentum strategies. This suggests that investors are more prone to extrapolate trends they consider salient. The performance of the trend salience signal is not explained by the Carhart [1997] four-factor model, indicating behavioral underpinnings of momentum that go beyond conventional factors.

In what scenarios does the trend salience signal demonstrate robust performance, and when does it falter?

The trend salience signal exhibits robust performance across various investment horizons and size-sorted portfolios. However, its effectiveness is time-varying. The strategy does not outperform momentum in “down” markets characterized by high volatility, where identifying salient trends becomes more challenging. This temporal variability underscores the nuanced nature of trend salience and its impact on momentum profitability.

How does the research contribute to our understanding of investor behaviors and the implications of trend salience in shaping momentum profitability?

The research contributes valuable insights into investor behaviors by highlighting the role of trend salience in shaping momentum profitability. The outperformance of the trend salience-based strategy challenges conventional models and emphasizes the behavioral underpinnings of momentum. The findings deepen our understanding of the complexities of investor decision-making and the nuanced interplay between trend salience and momentum in financial markets.

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