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Short-term Momentum Analysis

Last Updated on 10 February, 2024 by Rejaul Karim

In the research paper “Short-term Momentum” by Mamdouh Medhat and Maik Schmeling, the intriguing pattern found within U.S. and international stock returns is explored by examining double sorting based on the previous month’s return and share turnover.

The study uncovers a significant short-term reversal among low-turnover stocks, while high-turnover stocks display short-term momentum. This short-term momentum pattern is not only as profitable and persistent as conventional price momentum but also endures transaction costs.

Interestingly, the phenomenon is most prominent among the largest, most liquid, and extensively covered stocks. The findings present a challenge to models that assume strict rationality and suggest an alternative explanation based on traders’ potential underestimation of the information conveyed by prices.

This exploration of short-term momentum and reversal contributes to the ongoing dialogue surrounding patterns and dynamics within the stock market.

Abstract Of Paper

We document a striking pattern in U.S. and international stock returns: double sorting on the previous month’s return and share turnover reveals significant short-term reversal among low-turnover stocks, whereas high-turnover stocks exhibit short-term momentum. Short-term momentum is as profitable and as persistent as conventional price momentum. It survives transaction costs and is strongest among the largest, most liquid, and most extensively covered stocks. Our results are difficult to reconcile with models imposing strict rationality but are suggestive of an explanation based on some traders underappreciating the information conveyed by prices.

Original paper – Download PDF

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Author

Mamdouh Medhat
Dimensional Fund Advisors

Maik Schmeling
Goethe University Frankfurt – Department of Finance; Centre for Economic Policy Research (CEPR)

Conclusion

In conclusion, the research paper highlights a noteworthy pattern in U.S. and international stock returns, revealing that low-turnover stocks experience short-term reversal while high-turnover stocks demonstrate short-term momentum.

This phenomenon proves to be as profitable and persistent as conventional price momentum, and it sustains transaction costs. Intriguingly, short-term momentum is most pronounced among the largest, most liquid, and widely covered stocks.

These findings challenge the traditional models that assume strict rationality and suggest an alternative explanation rooted in traders potentially underappreciating the information conveyed by prices.

Medhat and Schmeling’s work thus provides valuable insights into the patterns and dynamics of stock returns, contributing to a more nuanced understanding of short-term momentum and reversal in financial markets.

Related Reading:

Trend Salience, Investor Behaviors and Momentum Profitability

The Formation Process of Winners and Losers in Momentum Investing

FAQ

What is the main finding of the research paper “Short-term Momentum” by Mamdouh Medhat and Maik Schmeling?

The research paper uncovers a notable pattern in U.S. and international stock returns. Through double sorting based on the previous month’s return and share turnover, the study reveals that low-turnover stocks exhibit a significant short-term reversal, while high-turnover stocks display short-term momentum. This pattern proves to be as profitable and persistent as conventional price momentum, even accounting for transaction costs.

How does the short-term momentum pattern differ among stocks with varying characteristics, such as size and liquidity?

The short-term momentum pattern is most pronounced among the largest, most liquid, and extensively covered stocks. This finding suggests that the phenomenon is particularly prominent in the context of well-established and widely observed stocks in the market.

How does the research challenge traditional models and what alternative explanation is proposed for the observed pattern in stock returns?

The findings of the research paper pose a challenge to models that assume strict rationality in the market. Instead, the study suggests an alternative explanation rooted in traders potentially underappreciating the information conveyed by prices. This alternative perspective highlights the role of market participants’ behavior and potential biases in contributing to the observed short-term momentum and reversal patterns in stock returns.

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