Momentum Effect in Stocks in Small Portfolios

Fundamental reason

Simple trading strategy

Out-of-sample strategy's implementation/validation in QuantConnect's framework(chart, statistics & code)

Source paper

Siganos: Can small investors exploit the momentum effect?

Abstract: This study uses U.K. data and investigates whether small investors can exploit the continuation effect in share prices. Individual traders are not in a financial position to buy and sell short hundreds of firms, as suggested by existing academic research, and thus this study uses extreme performance companies to implement the strategy. We find that strong momentum gains appear when extreme winners and losers are employed. These returns remain strong even after considering the transaction costs of implementing such strategies, including commissions, stamp duty, selling-short costs, and bid-ask spread. Overall, we show that a relatively large number of small investors can enjoy momentum gains, providing some evidence against stock market efficiency.

Other papers

• Ammann, Moellenbeck, Schmid: Feasible Momentum Strategies in the US Stock Market

  Abstract: While there is a large literature documenting the profitability of momentum strategies, their implementation is afflicted with many difficulties. Most importantly, high turnover and costs to hold short positions, especially in small-cap stocks, result in high transaction costs. We restrict our investment universe to large-capitalized stocks included in the S&P 100 index. Moreover, we implement simple investment strategies that invest long in single stocks and short in the stock index. Such simple and cost-saving momentum strategies generate economically high and statistically significant abnormal returns. These results are robust to various risk-adjustments including the CAPM, the Fama French (1993) three-factor model, and a conditional version of the Fama and French (1993) three-factor model.

• Foltice, Langer: Profitable Momentum Trading Strategies for Individual Investors

  Abstract: For nearly three decades, scientific studies have explored momentum investing strategies and observed stable excess returns in various financial markets. However, the trading strategies typically analyzed in such research are not accessible to individual investors due to short selling constraints, nor are they profitable due to high trading costs. Incorporating these constraints, we suggest and explore a simplified momentum trading strategy that only exploits excess returns from topside momentum for a small number of individual stocks. Building on US data from the New York Stock Exchange from 1991-2010, we analyze whether such a simplified momentum strategy outperforms the benchmark after factoring in realistic transaction costs and risks. We find that it is indeed possible for individual investors with initial investment amounts of at least $5,000. In further attempts to improve this practical trading strategy we also analyze an overlapping momentum trading strategy consisting of a more frequent trading of a smaller number of “winner” stocks. We find that increasing the trading frequency initially increases the risk-adjusted returns of these portfolios up to an optimal point when excessive transaction costs begin to dominate the scene. In a calibration study, we find that, depending on the initial investment amount of the portfolio, the optimal momentum trading frequency ranges from bi-yearly to monthly.

• Piras, Antonio, Concentrated Portfolios of Momentum Stocks

  Abstract: There exists abundant academic literature showing that momentum, i.e. a positive correlation between initial ranking of stocks by their past returns and subsequent returns, is pervasive across different markets and time periods. Although recent criticism speculates on the disappearing of momentum returns, as-set managers have launched strategies to harvest the risk premia in form of well diversified equities funds based. In this research paper I delve deeper into the topic of the construction of concentrat-ed portfolios with less than 50 stocks. Based on monthly data for the US market universe I first investigate the consistency of momentum returns over the latest 20 years (1999-2019) with deciles analysis and then study the characteristics both of unconstrained and sector neutral concentrated portfolios. The empirical results show that momentum in the last decade (2010-2019), measured as the performance of a zero investment portfolio (long winners and short losers), is present but with minor intensitycompared to the previous decade and that on the same period the top decile “long only” portfolio, built with previous winners’ stocks, still keeps beating the markets index with better Sharpe and Sortino ratios. The results on concentrated portfolios, in particular portfolios with less than 10 stocks, show clear dependency on the given universe constituents, to make the analysis less dependent on particular universe constituents I propose to run the momentum strategy on 1000 random subsampled stocks universes and show empirically that the relation between the number of stocks in the portfolios and the corresponding performances is statistically significant monotonic (the less stocks the more performance). Finally, I report that a sector neutral portfolio, i.e. a portfolio with the same number of stocks for each industrial sector, shows superior risk return characteristics than unconstrained ones. In the last 20 years a long only portfolio based on overlapping sector neutral sub-portfolios with 10 stocks each, gained an annualized return of 11.3% with a Sharpe ratio of 0.59, compared to a 6.00% and 0.24 for the MSCI USA and a 8.5% and 0.38 for the equal weighted benchmark.