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Finding Alphas: A Quantitative Approach to Building Trading Strategies by Igor Tulchinsky

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21 Introduction to Momentum Alphas

By Zhiyu Ma

Momentum alphas are an important group and a broad category of alphas. Here we define momentum alphas as average alpha values (the forecasted neutralized stock returns) that share the same signals with a period of past returns (of its own or some other stocks).

In 1993, Jegadeesh and Titman published the first paper on stock price momentum, “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency,” which stated that the winners/losers in the past 3 ~ 12 months are likely to continue to win/lose in the future. Later, many other researchers studied the same phenomenon and confirmed that it works in most stock markets and other financial markets around the world. In recent years, the profit of this alpha has shrunk a lot, and it suffered a large drawdown during the financial crisis of 2008. Then a lot of papers tried to modify the simple rule to enhance the potential profit and reduce the drawdown while keeping the spirit of the alpha. It is still an active field of research within the academic community.

Researchers try to give reasonable explanations as to why momentum alphas work. A well-accepted theory is investors’ underreaction to new information. In an imperfectly efficient market, it takes time to resolve and price the new information, as the stock prices gradually reach the target. This holds water when we investigate the impact of events on the markets. There is stock price momentum when public ...

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