{"id":881166,"date":"2020-08-30T06:30:37","date_gmt":"2020-08-30T06:30:37","guid":{"rendered":"https:\/\/stockviz.biz\/index.php\/2020\/08\/30\/the-momentum-factor\/"},"modified":"2021-09-14T08:40:09","modified_gmt":"2021-09-14T03:10:09","slug":"the-momentum-factor","status":"publish","type":"post","link":"https:\/\/stockviz.biz\/index.php\/2020\/08\/30\/the-momentum-factor\/","title":{"rendered":"The Momentum Factor"},"content":{"rendered":"\n

Only buy stocks that go up…<\/h2>\n\n\n\n

The Fama French 5-Factors came in two installments. The first 3<\/a> were published in 1992 and the rest<\/a> in 2014. They capture \u201cfundamental\u201d factors, i.e., factors that can be derived from looking at balance-sheet and income statements. In 1993, Jegadeesh and Titman published their ground-breaking work on momentum: Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency<\/em> (pdf<\/a>)<\/p>\n\n\n\n

Their paper singularly propelled momentum (or, trend-following) into the mainstream by giving it the academic vigor it lacked earlier. While its findings may not have been earth-shattering for most traders, most professional investors looked at momentum strategies as something that \u201ctraders\u201d did and avoided them. But within a decade of the paper being published, momentum strategies were firmly established as a \u201clegitimate\u201d strategy that could be allocated to.<\/p>\n\n\n\n

Basic Design<\/h2>\n\n\n\n

The J\/T paper constructs a long-short portfolio by ranking stocks based on their prior 12 month returns (skipping the most recent month.) The top decile portfolio is called the “losers” decile and the bottom decile is called the “winners” decile. In each month, the strategy buys the winner portfolio and sells the loser portfolio. This is the classic 12_1<\/strong> momentum, where 12 <\/strong>denotes the formation period<\/em> and the 1<\/strong> is the number of skip months<\/em>. <\/p>\n\n\n\n

The reason for the skip month<\/em> is to account for the short-term reversal effect associated with momentum. Some researchers, like Fama and French, do 12_2<\/strong> momentum, where the most recent 2 months are skipped. However, a more recent study by Medhat and Schmeling (2018<\/a>) finds that once we discard the stocks with the lowest turnover, equity returns exhibit short-term momentum rather than short-term reversal. So, the short-term reversal effect may not be as prevalent as is usually thought and one could even go with a 12_0<\/strong> momentum.<\/p>\n\n\n\n

The French Momentum Library<\/h2>\n\n\n\n

Luckily for us, Ken French (of the Fama French fame) regularly updates factor statistics on his Tuck School of Business webpage<\/a>. <\/p>\n\n\n

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