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Low-Cost Momentum Strategies

Last Updated on 10 February, 2024 by Rejaul Karim

Exploring the influence of trading costs on momentum strategies in the UK, the research paper “Low-Cost Momentum Strategies” by Xiafei Li, Chris Brooks, and Joëlle Miffre provides valuable insights into the world of investments.

Their findings reveal that trading loser stocks tends to be more expensive than trading winner stocks, primarily due to the substantial costs associated with selling small size and low trading volume loser stocks.

Recognizing the significant effect transaction costs have on net momentum profits, the authors introduce a new low-cost relative-strength strategy which emphasizes selecting winner and loser stocks with minimum transaction costs. While the research questions the viability of traditional momentum strategies, it suggests that momentum-based return enhancement could still be achieved by asset managers who implement low-cost relative-strength strategies.

Abstract Of Paper

The article analyses the impact of trading costs on the profitability of momentum strategies in the UK and concludes that losers are more expensive to trade than winners. The observed asymmetry in the costs of trading winners and losers crucially relates to the high cost of selling loser stocks with small size and low trading volume. Since transaction costs severely impact net momentum profits, the paper defines a new low-cost relative-strength strategy by shortlisting from all winner and loser stocks those with the lowest total transaction costs. While the study severely questions the profitability of standard momentum strategies, it concludes that there is still room for momentum-based return enhancement, should asset managers decide to adopt low-cost relative-strength strategies.

Original paper – Download PDF

Here you can download the PDF and original paper of Low-Cost Momentum Strategies.

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Author

Xiafei Li
Keele Business School, Keele University; Keele Business School, Keele University

Chris Brooks
University of Bristol – School of Economics, Finance and Management

Joëlle Miffre
Audencia Business School

Conclusion

In conclusion, the research paper “Low-Cost Momentum Strategies” by Xiafei Li, Chris Brooks, and Joëlle Miffre offers a critical examination of the effects of trading costs on momentum strategies in the UK. The study highlights the asymmetric costs of trading winners and losers, with losers proving to be more expensive due to the high costs associated with small size and low trading volume stocks.

Given the substantial impact of transaction costs on net momentum profits, the authors present a novel low-cost relative-strength strategy that focuses on selecting stocks with the lowest transaction costs. While the research raises doubts regarding the profitability of traditional momentum strategies, it also opens the door for potential momentum-based return enhancement through the adoption of low-cost relative-strength strategies by asset managers.

This innovative approach offers new possibilities for maximizing returns while minimizing costs in the ever-evolving world of investments.

Related Reading:

Momentum and Funding Conditions

Sources of Momentum Returns: A Decomposition of the Explained and the Unexplained Risk Factors

FAQ

Q1: What is the key finding regarding the impact of trading costs on momentum strategies in the UK?

The research finds that trading loser stocks tends to be more expensive than trading winner stocks in the UK. This asymmetry in trading costs is attributed to the high costs associated with selling small size and low trading volume loser stocks. Understanding this cost differential is crucial for evaluating the overall profitability of momentum strategies.

Q2: How do transaction costs affect net momentum profits, and what is the proposed solution to address this impact?

Transaction costs significantly impact net momentum profits, especially considering the higher costs associated with trading loser stocks. In response, the authors introduce a new low-cost relative-strength strategy. This strategy involves selecting winner and loser stocks with the minimum total transaction costs, aiming to mitigate the negative impact of trading costs on momentum strategy profitability.

Q3: What is the main implication regarding the viability of traditional momentum strategies based on the research findings?

The research questions the viability of traditional momentum strategies, highlighting the challenges posed by trading costs, particularly in the context of losers. The asymmetry in costs raises doubts about the overall profitability of standard momentum approaches. However, the study suggests that there is still potential for momentum-based return enhancement through the adoption of low-cost relative-strength strategies.

You can find many more Research Papers here

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