Betting against losers

A momentum portfolio has two hands. One buys last month's winners, the stocks that rose the most. The other sells short last month's losers, the stocks that fell the most, betting that they keep falling. Betting against losers is that second hand, and it is what turns a simple "buy what is rising" into a long-short portfolio.

It matters because the second hand is what makes the test honest. A portfolio that only buys winners, in a market that rises, gains whenever the market gains, so its chart climbs even if the picks carry no information at all. Shorting the losers takes the market back out: if the whole list rose, the short hand gives that rise back, and what remains is the real question of whether winners beat losers. It is also the expensive hand. It pays a borrow fee, the shares can be recalled, and a beaten stock that snaps back can lose without limit.

In the logbook's short-term momentum entry, each hand on its own gained about a point and a half a month, because the market was lifting both. Once the portfolio also bet against losers, the two cancelled and the result after costs was a small loss. The question to put to any momentum chart is what happens to the curve when the losers are shorted too.