Momentum Trend Trading Strategy has been described as one of the most persistent stock market strategies and investors can capitalize on this phenomenon to earn above average market returns.
One of the first studies on momentum came from Jegadeesh who measured the price momentum of stocks based on three to twelve month rolling returns.
Jegadeesh found that stocks with the strongest 12-month returns went on to outperform the market over the next 12 months and smilar findings were found in monthly intervals down to 3 months.
Other profitable momentum strategies have been published which include closeness to the 52-week high and entries using moving averages.
In 2010, a paper by Park showed that sorting stocks based on the ratio between the 50-day moving average and 200-day moving average provided monthly returns of 1.45% with 6-month holding periods.
The idea is you divide the 50-day MA with the 200-day MA and go long the stocks in the top decile (winners) and short stocks in the bottom decile (losers).
This is a simple method to define momentum and we have also demonstrated several moving average systems on this website and in our research program.
When trading momentum, several studies have concluded it’s wise to ignore the most recent month in calculations because the most recent month tends to show price reversal instead.
In the case of 12 month momentum by Jegadeesh, the most recent month is left out of the calculation.
Other, more recent studies have failed to discredit momentum as a viable market anomaly and it remains one of the better market edges available to ordinary investors.
One study that looked into the overall profitability of 447 market factors, found that up to 85% were insignificant and probably the result of backtesting bias.
However, momentum factors were frequently mentioned as among the most significant of those 447 tested.
Momentum also has a long history of good performance as illustrated by the following graph from Geczy and Samonov:
Momentum Trend Trading Strategy
There are numerous different strategies that investors can use to exploit the momentum anomaly over different time horizons.
Momentum systems can be based on moving averages, breakouts and monthly returns and there are plenty of strategies documented on this website and in academic journals.