Blog - Investing Notes

August 23, 2006 - Momentum Strategies Sputtering?

How are momentum stock trading strategies doing these days? In their January 2006 paper entitled "The Vanishing Abnormal Returns of Momentum Strategies and 'Front-running' Momentum Strategies", Thomas Henker, Martin Martens and Robert Huynh examine the returns of various momentum trading strategies in general and during specific market conditions (rising or falling) over the period 1993-2004. They construct a series of self-financing portfolios (equal-weighted) for various holding periods by buying past winners and selling past losers based on various past performance (ranking) periods. Some strategies include a one-month gap between the ranking and holding periods. They repeat portfolio construction monthly over the sample period for each strategy, resulting in overlapping portfolios. Finally, they test "front-running" strategies that set momentum rankings five days before the ends of months rather than at month-ends. Using daily data to calculate monthly returns for a broad sample of stocks (with all distributions reinvested), they find that:

• Because of weak results during the bear market of the early 2000s, self-financing momentum strategies in general did not reliably generate significant returns across the entire 1993-2004 period.
• Momentum strategies work better during a rising market than during a falling market.
• Momentum strategy results are generally stronger and less volatile for the stocks of medium-sized and large firms than those of small firms.
• Momentum strategies work better for NYSE/AMEX stocks than for NASDAQ stocks.
• "Front-running" momentum strategies generally outperform month-end strategies because of lower volatilities, suggesting perturbations from month-end institutional trading. The "front-running" enhancement appears to be concentrated in small stocks.

In summary, there are a lot of twists and turns to momentum strategy returns. Momentum players should pay attention to the subtleties.

For related research, see Blog Synthesis: Momentum Investing/Trading.