Momentum is one of the most well-documented anomalies in financial markets. The core idea is simple: stocks that have performed well recently tend to continue performing well in the near future, and stocks that have performed poorly tend to continue underperforming.
Types of Momentum
- Price Momentum (Time-Series): Buy stocks with positive returns over a lookback period (e.g., 12 months minus the most recent month)
- Cross-Sectional Momentum: Rank all stocks by returns, buy the top decile, sell the bottom
- Earnings Momentum: Trade based on the direction of earnings revisions or surprises
- Dual Momentum: Combine absolute momentum (positive returns) with relative momentum (outperforming peers)
Common Parameters
| Parameter | Typical Range |
|---|---|
| Lookback period | 6–12 months |
| Skip period | 1 month (avoids mean reversion) |
| Holding period | 1–3 months |
| Number of stocks | 10–30 |
Risks
- Momentum Crashes: Sharp reversals can cause significant losses (e.g., 2009 recovery)
- High Turnover: Frequent rebalancing increases transaction costs
- Crowding: As more traders follow momentum, alpha may diminish