The traditional momentum effect is one of the most well-known and best-documented stock market anomalies. Also, some notable research about the persistency of momentum effect has already taken place at the portfolio level (for example, Chen et al., 2014). However, recent research has taken the issue a bit further, focusing on the performance variation at the firm level rather than on a more general portfolio level. Based on the “top decile long and bottom decile short” approach, the empirical evidence shows, inter alia, that only about 60% of the winner/loser stocks in the sample were consistent winners (losers) – in the top (bottom) decile both during the month of portfolio formation and in the following month – and that at least 1/4 of them even experienced a contrarian effect in the post-formation month. The authors of the recent academic research show that consistent winner stocks outperform inconsistent winner stocks, and conversely, consistent loser stocks underperform inconsistent loser stocks, in the post-formation period. With respect to this result, they suggested a strategy of buying consistent winners while selling consistent losers, which outperformed the traditional and ‘inconsistent’ momentum with 1.25% average monthly return (significantly positive even after adjusting for Fama-French‘s three factors and Carhart’s momentum factor, as opposed to the traditional and inconsistent momentum strategies with 1.06% and 0.47% average monthly returns, respectively).

Fundamental reason

Momentum anomaly is, in general, related to investors’ irrationality – they underreact to new information as they do not incorporate news in their transaction prices sufficiently. Under the information asymmetry and the heterogeneous beliefs hypotheses, the persistence of momentum effect depends on size, idiosyncratic volatility, % of institutional ownership, and trading volume. According to the former, investors tend to be conservative in the case of stocks with higher idiosyncratic volatilities and a lower percentage of outstanding stocks owned by institutional investors (they become consistent winners/losers due to slow price adjustment). The latter suggests that higher trading volume on stock (a proxy for disagreement among investors) should produce a stronger momentum effect.

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Markets Traded

Financial instruments

Confidence in anomaly's validity

Backtest period from source paper

Notes to Confidence in Anomaly's Validity

Indicative Performance

Period of Rebalancing
6 Months

Notes to Indicative Performance

per annum, annualized (geometrically) average monthly return of 1,25%, data from table 9

Notes to Period of Rebalancing

Estimated Volatility

Number of Traded Instruments

Notes to Estimated Volatility

estimmated from t-statistic, data from table 9

Notes to Number of Traded Instruments

more or less, it depends on investor’s need for diversification

Maximum Drawdown

Complexity Evaluation
Complex strategy

Notes to Maximum drawdown

not stated

Notes to Complexity Evaluation

Sharpe Ratio

Simple trading strategy

The investment universe consists of stocks listed at NYSE, AMEX, and NASDAQ, whose price data (at least for the past 7 months) are available at the CRSP database. The investor creates a zero-investment portfolio at the end of the month t, longing stocks that are in the top decile in terms of returns both in the period from t-7 to t-1 and from t-6 to t, while shorting stocks in the bottom decile in both periods (i.e. longing consistent winners and shorting consistent losers). The stocks in the portfolio are weighted equally. The holding period is six months, with no rebalancing during the period. There is a one-month skip between the formation and holding period.

Hedge for stocks during bear markets

Not known - Source and related research papers don’t offer insight into the correlation structure of the proposed trading strategy to equity market risk; therefore, we do not know if this strategy can be used as a hedge/diversification during the time of market crisis. The strategy is built as a long-short, but it can be split into two parts. The long leg of the strategy is surely strongly correlated to the equity market; however, the short-only leg can be maybe used as a hedge during bad times. Rigorous backtest is, however, needed to determine return/risk characteristics and correlation.

Source paper
Chen, Chou, Hsieh: Persistency of the Momentum Effect: The Role of Consistent Winners and Losers
- Abstract

Momentum profits, resulting from buying winners and selling losers, are robust in the stock market; however, less than 60% of winner and loser stocks remain in winner and loser groups in the subsequent formation month. This study applies duration analysis to test the persistency of the momentum effect and demonstrates that consistent winners and losers experience higher subsequent momentum profits than inconsistent winners and losers. Consistent with the information asymmetry hypothesis and the heterogeneous beliefs hypothesis, the momentum persistency is associated with size, idiosyncratic risk, institutional ownership, and trading volume. In addition, an asymmetric effect is observed—the post-formation return contributes to the winner persistency more, while the formation period return can explain the loser persistency more. The duration analysis also demonstrates that the trading volume reflects effects of both heterogeneous beliefs among investors and the momentum life cycle. The consistent momentum strategy may offer enhanced performance, despite controlling for factors associated with

market risk, size, book-to-market ratio, momentum effect, and liquidity risk.

Other papers

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