If youre a momentum trader, pay attention. You might be missing the greatest momentum trade of all time: the S&P 500. Thats the case A Wealth of Common Senses Ben Carlson recently made in a blog post discussing the counter-intuitive nature of S&P component performance over time.
Carlson presented the following chart of the total lifetime returns of 14,455 active U.S. stocks between 1989 and 2015.
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Stock performance is far from a bell curve. During a quarter century when the S&P 500 gained nearly 1200 percent, the worst-performing 11,513 of the 14,455 stocks represented in the chart above generated an overall net return of 0 percent. Incredibly, what that means is that the overall gains of the entire group came from the huge over-achievement of the top 20 percent of stocks.
Carlson argued that momentum investors should recognize this phenomenon.
Momentum investors cut their losers and let their winners run, he wrote. In a roundabout way, thats exactly what the stock market has done over time.
Carlson said that one of the reasons why an index like the S&P 500 is so difficult for active managers to beat is that it is extremely difficult for humans to hold onto huge winners like Apple Inc. (NASDAQ:AAPL), Alphabet Inc (NASDAQ:GOOG) (NASDAQ:GOOGL) and Amazon.com, Inc. (NASDAQ:AMZN) over an extended time period and not take profits at some point along the line. Each of these three stocks, for example, is up more than 1,000 percent in the past 15 years, and Apple is up nearly 3,000 percent.
How many of us would have had the ability to hang on as those gains compounded and the market caps kept rising? Carlson asked.
In conclusion, Carlson notes that index funds like the SPDR S&P 500 ETF Trust (NYSE:SPY) inherently have the discipline and risk apathy to let the winners ride, while the losers are constantly falling by the wayside. In that sense, the S&P 500 is the perfect example of momentum trading in action.
Disclosure: The author holds no position in the stocks mentioned.
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