Can Momentum Strategy Avoid Manipulated Stocks
The big fear for most investors is about getting caught on the wrong side of a stock that went up only due to manipulation and once the deed has been done, has lost all of its gains without providing investors an opportunity to exit.
I recently did a Twitter Spaces talk and this was one of the questions raised. While getting caught in manipulated stocks is possible regardless of the strategy one follows, the lack of narrative and fundamental reasoning for Momentum leaves us particularly exposed.
Pump and Dump is something that is not new but one that has been evident from the time we had stock markets. The oldest example of that would be in the South Sea Bubble.
There are basically two kinds of Pump and Dump that happens. One involves manipulating the accounts so as to suggest the company is doing way better than it is really doing while the other involves just squeezing the price higher without fundamental triggers.
Cases like Satyam Computers, Vakrangee among others belonged to the first group. The accounts were not a true reflection of what the reality was and this enabled the price to shoot higher.
Cases of pure Pump and Dump of stock prices are dime a dozen. Stocks seem to go higher and higher for no reason and with very little volumes before a reversal happens and all the gains are lost.
The pure price based pump and dump is actually easy to evade for Momentum Investors. Have a high enough bar of how much value a stock should trade on a normal day (for a long enough period) and voila, 99% of such stocks will get automatically rejected. Pump and Dumps that don’t have a fundamental backing generally are operated by a small coterie and are not really well traded.
The fundamental driven frauds are much tougher in that sense. When Vakrangee for instance was going up, it was accompanied by positive spin. Some positive tweets / articles of those times
Heck, the stock even made it to MSCI Largecap Index. Not that everyone was gung ho on it, Nooresh Merani and Amit Mantri were among the few to question it
But there was not a single tweet I could find that had the words Vakrangee and Fraud. Of course calling out Fraud on even Fraud companies in India is Risky and one would rather not be invested than question companies that have connections which can result in midnight calls or even sent to jail.
I got caught in my personal account in Vakrangee. While I did interact with very many intelligent folks, I decided to hold onto the stock since selling would be essentially breaking the cardinal rule of Systematic Investing – adding the discretionary element that one hopes to eliminate.
I was lucky in the sense that when the stock made its top, my return from the stock was at 100% and when I got the ability to exit, it was back at my entry price. So, even after a 50% fall, I got out at cost with the only loss being opportunity cost.
I was not having a Momentum Investing strategy when Satyam Crashed but the crash unlike that of Vakrangee took place at the high point. Rather, the stock was down 78% from it’s all time high and down 67% from its 52 week high. Momentum strategies would have long ignored this stock and would have had no impact whatsoever.
Yet, there is no saying the next stock that may be part of a Momentum Strategy and turn out to be a fraud. Or for that matter, stocks can fall big time within the timeframe of a rebalance without there being any fraud.
In March 2020 for instance, one of my PF constituents was AU Bank. The stock was bought on the 1st trading day of the month at around 1150 and by the end of the month was at 500. A 57% fall in one of the stocks can be fatal to any Portfolio and my was not immune especially since I was having a significant weight to financials which bore the brunt of the damage.
What saved me though was that I have always felt that since we are dealing with a lot of unknowns, a good amount of diversification while reducing the returns slightly can enhance from the risk management angle. In a 30 stock portfolio, each stock has a weight of just 3.33% (approximately) and even if a stock was to go down 50% before you can exit, the damage (assuming the rest of the stock overall did not fall like a pack of cards), the damage to the portfolio is just 1.67% – something that is honestly very much bearable.
Other risk management techniques that can be used are trailing stops, stops based on either the equity curve or based on moving average on a benchmark index among others. The risk of trying to manage risk though in a way can actually enhance the volatility since there would be more stocks in motion (going in and out).
While four years is too short a time frame to judge a strategy – Meb Faber recently tweeted that he believed that to clearly judge a strategy as being good or bad required 20 years of data – my experience tells me that with a good set of filters and maybe once in a way allowing the luxury of not entering a stock even if it tops the momentum list (I did it with Adani Green, Tanla among others), risk of getting into stocks that you don’t have a easy exit can be vastly avoided.
At Portfolio Yoga, our aim is not to maximize reward but to maximize the ability to deploy a larger capital. A 20% gain that comes via a risky portfolio is worse than a 15% gain that can come through a lower risk (there is nothing like no risk) portfolio but one where you can confidently deploy a much larger percentage of your money.
On that note, let me leave you with this post from Seth Godin – Optimized or maximized?
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