Question

''It shouldnt work, yet the record is robust. Stocks that have risen in the past, tend to keep rising, on average, for the next several months. stocks that have done poorly, tend to keep failing. This is called momentum. The momentum factor has proven robust over 200 years, out of sample and across markets and geographies. Roughly, it may deliver a return about 10% higher than the market per year, based on history, before taxes and fees.''

Required

Determine which forms of the efficient markets hypotheses is contradicted by a momentum strategy whereby investors can use past stock returns to form a portfolio with positive alpha. [12marks]

Answer 1

I will advocate that momentum strategy is contradicting strong form as well as weak form of market efficiency because the momentum strategy reflects that stocks that have risen in the past are rising in the futures also, so it is reflecting that it has not discounted the past informations, and it is a contradiction of strong form of market efficiency.

It is also a contradiction of weak form of market efficiency because it is violating that historical trends and prices are not discounted in the present value.

Technical analysis is not appropriate in case of weak market form efficiency so it is also a violation of weak form, because it is implying a lot of technical Analysis.

So, momentum strategy is a violation of both strong form of market efficiency and weak form of market efficiency