Momentum is the tendency for assets that have performed well (poorly) in the recent past to continue to perform well (poorly) in the future, at least for a short period of time. In 1997, Mark Carhart, in his study, “On Persistence in Mutual Fund Performance,” was the first to use momentum, together with the three Fama–French factors (market beta, size, and value), to explain mutual fund returns. Initial research on momentum was published by Narasimhan Jegadeesh and Sheridan Titman, authors of the 1993 study, “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency.”(1)
Momentum is most commonly defined as the last 12 months of returns excluding the most recent month (in other words, months two through 12 of the past year). The most recent month is excluded, as it tends to show a reversal, which some have attributed to microstructure (trading) effects. The momentum factor is the average return of the top 30 percent of stocks minus the average return of the bottom 30 percent as ranked by this measure. The momentum factor is referred to as UMD, or up minus down. Note that UMD is a relative (cross-sectional) measure of momentum, unlike trend-following momentum, which is an absolute measure.
Cross-sectional momentum has been found to be persistent across time and economic regimes; pervasive around the globe and across stocks, industries, bonds, commodities and currencies; robust to various definitions; and has well-documented behavioral explanations for why it has persisted even after publication. And, with the use of patient trading strategies, it survives transaction costs.(2)(3)(4)
Introducing Factor Momentum
Rob Arnott, Mark Clements, Vitali Kalesnik and Juhani Linnainmaa contribute to the literature on momentum with their January 2018 study “Factor Momentum.” The authors identified 51 factors in the academic literature found to be significant predictors of stock returns and showed that factor momentum is not only stronger than the previously documented industry momentum, it fully subsumes it. The data sample covers the period from July 1963 through 2016.
