A reader asked: “In reviewing your various posts on momentum-based trading, I noticed that many impose a one-month delay between momentum calculation and actual trade implementation. Is the effect/rational for this strategy adjustment referenced anywhere or is this something you can comment on?”
The original momentum research (Jegadeesh and Titman, 1993, “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency,” Journal of Finance 48, pp 65- 91) introduced a skip-period as an alternative momentum strategy. The rationale is as follows (from the 2001 paper entitled “Momentum” by Jegadeesh and Titman):
“Jegadeesh (1990) and Lehmann (1990) examine the performance of trading strategies based on one week to one month returns and find that these short horizon strategies yield contrarian profits over the next one week to one month…
“…Jegadeesh and Titman (JT) (1993) examine the performance of trading strategies with formation and holding periods between three and 12 months. Their strategy selects stocks on the basis of returns over the past J months and holds them for K months. This J-month/K-month strategy is constructed as follows: At the beginning of each month t, securities are ranked in ascending order on the basis of their returns in the past J months. Based on these rankings, JT form ten equally weighted decile portfolios. The portfolio with the highest return is called the ‘winners’ decile and the portfolio with the lowest return is called the ‘losers’ decile.
“Jegadeesh and Titman (1993) examine U.S. stocks during the 1965 to 1989 period. Table I reports the average returns of the different buy and sell portfolios as well as the zero-cost, winners minus losers portfolio, for the strategies described above. All strategies considered here earn positive returns. The table also presents the returns for a second set of strategies that skip a week between the portfolio formation period and holding period. By skipping a week, these strategies avoid some of the bid-ask spread, price pressure, and lagged reaction effects documented in Jegadeesh (1990) and Lehmann (1990).”
The rationale is recognition of a short-term reaction for stocks with momentum concentrated in a recent interval. Many subsequent papers and analyses are extensions or recent tests of the original findings. Some include a skip-period (a month for those using monthly data) in their strategies, and others do not.
Reader Mal Williams reported that he has tested his momentum-based asset class rotation strategy (see “An Investor’s Asset Class Momentum Trading Strategy”) with and without a skip period, and that it performs better without by about 2% annually over 19 years.
It may be that the original finding is a result of data mining or that skip-periods do not apply for monthly intervals.
