Relative strength momentum portfolio
Momentum is the empirically observed tendency for rising prices to rise further. For example, a Jegadeesh and Titman (1993) study showed that stocks with strong performance over the past 3 to 12 months continue to outperform over the next 12 months. The high momentum stocks also outperform stocks with poor past performance in the next period.
The existence of momentum is a market anomaly, which finance theory has been struggling to explain. That is, it is a market inefficiency. The difficulty is that an increase in asset prices, in and of itself, should not warrant further increase. Such increase, according to the efficient-market hypothesis, is warranted only by changes in demand and supply or new information (cf. fundamental analysis). We can attribute the appearance of momentum to cognitive biases, which belong in the realm of behavioral economics. The explanation is that investors are irrational (Daniel, Hirschleifer, and Subrahmanyam, 1998 and Barberis, Shleifer, and Vishny, 1998), in that they underreact to new information by failing to incorporate news in their transaction prices. However, much as in the case of price bubbles, recent research has argued that momentum can be observed even with perfectly rational traders (Crombez, 2001).
Academics and quantitative investment managers alike, such as Shell Capital Management, have documented that Momentum is one of the strongest existing anomalies. The empirical finding that the markets, stocks, and sectors that have performed well in the past tend to continue to perform well in the future. Those that performed poorly in the past tend to perform poorly in the future.
