If a posteriori knowledge is merely that which based on experience, (ie it is empirical) then that is the best sort of knowledge on which to make decisions about the future IMO.
No, a priori knowledge is the best sort of knowledge on which to make decisions about the future. But since there are no purely a priori truths about the market (in the sense that it is impossible for them to be wrong, because they are inherently true), the best sort of knowledge on which to make decisions about the future is knowledge that both has an underlying logical explanation and can be demonstrated empirically, which I think is what arebelspy is getting at. As he pointed out earlier, if an investing strategy based on making trades every other Tuesday in months starting with the letter J or M, except in years ending in double-digit primary numbers, happened to backtest perfectly, would you trust it to continue to work into the future?
The logic behind momentum, from what I have read over the past six or so hours, is that humans are fearful and irrational. They buy high and sell low.
Miles, do you agree with this? Is there any other logic behind this strategy? If not, it's interesting to note that the logic behind this strategy is in some sense fundamentally pessimistic (it relies on an assumption of human irrationality/stupidity) while the logic behind buy and hold indexing is fundamentally optimistic (it relies on an assumption of human productivity/ingenuity).
There are multiple explanations for momentum. Some efficient market types even try to explain it as a risk story which has never made a bit of sense to me and just ends up seeming Panglossian.
I don't think that momentum has to do with human irrationality or stupidity, in a pejorative way. I think it has to do with the heuristics that govern human decision-making. i'm talking recency, loss aversion, representativeness, etc. i.e. everything in Daniel Kahneman's thinking fast and slow. These are useful techniques that we all use to process information quickly, but they are nonstatistical ways of thinking.
There is also some good data that momentum is perpetuated by the flow of capital in and out of funds. So as one strategy becomes successful based on regime change, money flows toward it in the short-term from other funds creating price momentum (and negative momentum from the donor funds!). And because money cannot flow instantaneously because of liquidity issues, this momentum lasts for a significant amount of time (anywhere from 3 to 12 months).
To me momentum is an expression of humanity as it exists, not as we think it exists.
We all believe ourselves to be rational, but we have irrational reactions to loss, and to prospective gain. We all chase performance (which is probably why there is such a strong predilection here for passive low cost investment. It is the SmartMoney bet!)
But to me passive investment has always been about one thing and one thing only. Low costs.
Passive investment wins because it is cheaper. Period. Full stop.
That's it. All of the arguments about winners and losers, zero sum games, and market efficiency strike me as post Facto rationalization. What matters to me is getting exposure to the market at the lowest price possible.
And one of the best things about the dual momentum strategy is that it trades so incredibly infrequently and can be implemented with only low-cost Cap weighted index funds.
To be sure there is some friction in the form
of bid ask spreads, so it is a little bit more expensive than buy-and-hold. But you trade about as often as you rebalance in a yearly rebalance.
But if you believe that the momentum anomaly is real, and is likely to persist, then it is easy to get exposure to it for cheaper than it is to get exposure to other factors like size, value, quality etc.
So to me the momentum story could not be more persuasive. But admittedly that's probably because its The fastest horse out there as far as I can see right now.