Profitable Momentum Trading Strategies for

Individual Investors
Bryan Foltice, Thomas Langer*
Finance Center Münster, University of Münster, 48143 Münster, Germany

Abstract

For nearly three decades, scientific studies have explored momentum investing strategies and
observed stable excess returns in various financial markets. However, the trading strategies
typically analyzed in such research are not accessible to individual investors due to short
selling constraints, nor are they profitable due to high trading costs. Incorporating these
constraints, we explore a simplified momentum trading strategy that only exploits excess
returns from topside momentum for a small number of individual stocks. Building on US data
from the New York Stock Exchange from July 1991 to December 2010, we analyze whether
such a simplified momentum strategy outperforms the benchmark after factoring in realistic
transaction costs and risks. We find that the strategy can indeed work for individual investors
with initial investment amounts of at least $5,000. In further attempts to improve this practical
trading strategy, we analyze an overlapping momentum trading strategy consisting of a more
frequent trading of a smaller number of “winner” stocks. We find that increasing the trading
frequency initially increases the risk-adjusted returns of these portfolios up to an optimal
point, after which excessive transaction costs begin to dominate the scene. In a calibration
study, we find that, depending on the initial investment amount of the portfolio, the optimal
momentum trading frequency ranges from bi-yearly to monthly.

JEL Classifications: G11, G12, G14

Keywords: Momentum Investing, Personal Finance, Portfolio Management

Bryan Foltice - University of Münster, Münster, Germany - Email: [email protected]

Electronic copy available at: https://ssrn.com/abstract=2602320

Researchers have been writing about momentum trading since the 1990s. In their original

work, Jegadeesh and Titman (1993) found that buying (shorting) the 10% best (worst)

performing stocks from the previous 3, 6, 9, and 12 months can result in abnormal profits of

approximately 1% per month after holding each portfolio for 3, 6, 9, or 12 months. Other

empirical research finds the same results in various markets around the world with

Rouwenhorst (1998) finding profits in 12 European countries, profits in emerging markets

(Cakici, Fabozzi, & Tan, 2013; Rouwenhorst, 1999), and positive returns in 31 of 39

international markets (Griffin, Ji, & Martin, 2003). Asness, Moskowitz, and Pedersen (2013)

evaluate momentum jointly across eight various markets and find consistent momentum

return premia across all evaluated markets. Fama and French’s three-factor model (1993)

cannot sufficiently explain the continuation of short-term returns found in the United States

(Jegadeesh & Titman, 1993; 2001). They later describe the abnormal returns yielded by

momentum strategies as the “premiere anomaly” of their three-factor model (Fama & French,

2008). Unfortunately for individual investors, momentum investing, as originally outlined by

Jegadeesh and Titman (1993), assumes a zero-cost trading strategy, which omits various

market frictions, such as transaction costs, bid-ask spreads, and short-selling constraints.

Carhart (1997) concludes that momentum trading, as proposed by Jegadeesh and Titman

(1993), becomes unprofitable after factoring in such trading costs.

Although the theory of momentum investing is well documented in literature, the body of

applied research as it pertains to individual investors is relatively small. Rey and Schmid

(2007) use Swiss data to show that investors could earn profits up to 44% annually by buying

the top performer in the SMI and selling short the worst performer in the same formation

period. In the US market, Ammann, Moellenbeck, and Schmid (2011) find significant

abnormal monthly returns of 1.16% to 2.05% by buying the single best performing stock in

Electronic copy available at: https://ssrn.com/abstract=2602320

too costly for retail investors “to buy/sell short hundreds of stocks” and employs U.K. data for

the top and bottom 1-50 best and worst performers. Siganos concludes that after accounting

for transaction costs and risk that small investors (with portfolios ranging from £5,000 to

£1,000,000) can exploit the momentum effect with only a limited number of stocks.

Furthermore, this work finds evidence that momentum profits increase as the number of

stocks in the portfolio decreases (Siganos, 2007).

These works lay an encouraging foundation for small investors and a solid framework for our

analysis. However, these papers imply that private investors have the capability to short

stocks in their portfolio. 1 Momentum trading, as proposed by previous literature, exposes

investors to unlimited downside risk by short selling uncovered positions in their portfolios.

Moreover, private investors would have to contend with additional “hard to borrow” fees. 2

Margin risk is also something that accompanies short selling and should be only engaged by

very knowledgeable investors who understand the risks involved. 3 Thus, this paper examines

the feasibility of private investors profiting from buying long only the “winner” portfolio. 4

Individual investors do not have many opportunities to consistently outperform the

benchmark. Research shows that in the nearly $12 trillion mutual fund industry, only 0.6% of

all mutual funds outperformed the benchmark after accounting for risks, expenses, and

management fees (Wermers, Barras, & Scaillet, 2010). Even if mutual funds that beat the

benchmark exist, the question remains: How would an individual investor choose the correct

1
Although it is unclear how many investors have the option to short stocks in their account, Barber and Odean
(2009) show that only 0.29% of all individual investors took short positions in their portfolio.
2
If a customer has shorted a stock, the clearing firm has to borrow it in order to deliver it to the buyer. When
there is a huge demand to short a stock and there is a shortage of shares to borrow, holders of long stock can
charge potentially very high rates to borrow stock.
3
Margin requirements for small and microcap stocks are often much higher than the standard 30-50% margin
requirement.
4
According to Jegadeesh and Titman’s (1993) and Grinblatt and Moskowitz’s (2004) findings, the abnormal
performance of momentum trading is mainly due to the winner portfolio rather than the loser portfolio.
3

Electronic copy available at: https://ssrn.com/abstract=2602320