“… we slavishly follow the model. You do whatever it says no matter how smart or dumb you think it is.”
– Jim Simons, Renaissance Technologies1
The components and knowledge required to understand the quantitative momentum system are outlined in Chapters 5 through 7. In Chapter 5, we outline the generic relative strength momentum indicator commonly used in academic research. Generic momentum is a starting point in the quantitative momentum system. We calculate the generic momentum measure as the total return (including dividends) of a stock over some particular look-back period (e.g., the past 12 months) and skip the most recent month. We calculate this measure for all stocks in our investment universe.
The next aspect of the quantitative momentum system relates to how we differentiate among generic momentum stocks. If you recall, in Chapter 6 we speak to the evidence on two aspects of investor behavior: (1) a preference for lottery-like assets and (2) limited attention. We first show the evidence that stocks with large short-term “spikes” in performance generally underperform. This underperformance is the result of mispricing caused by biased investors who overpay for lottery-like stock characteristics. Next, we examine the so-called frog-in-the-pan momentum algorithm (FIP), which attempts to quantify the path of a high momentum stock. The calculation for the measure is described as follows:
The FIP measure looks at the past 252 ...