Short thread about momentum as a risk factor and why you should take it seriously. At first glance it sounds stupid — why would stocks that recently went up continue to move together in the future?
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That is, more volatile (= relatively more important) factors will move stock prices more, so the momentum factor will load up on them, in proportion to how important they are.
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It’s common to neutralise momentum to other factors (eg sectors, countries, size etc). In the limit where you neutralize to all known factors, momentum is a summary of exposure to all the *unknown* factors, the stuff you didn’t model because you didn’t know about it.
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That’s why you should include momentum in your risk model even if you don’t plan to use it as a source of alpha — it’s a simple, robust way of modelling the risks that you aren’t smart enough to think of in advance.
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Gotta imagine there are some busy bees using machine learning to tease out these latent *unknown* factors. Tempted to give it a shot myself now, thanks for the inspiration!
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