Momentum in equities refers to the purchase of stocks that have had high returns in the past (typically over the past 3-12 months) and the sale of those who had poor returns over the same time period. It is an empirically observed tendency for rising prices to rise further and falling prices to fall more. Signals based on a 52-week high have been used by analysts in buy and sell recommendations.
Back-test implementation of momentum on S&P500 stocks:
- Calculate daily returns of S&P500 stocks
- Calculate average returns per look-back window (e.g. 3-12 months)
- Roll the average returns calculations one day at a time
- Sort stocks by returns – select top n and bottom n stocks
- Track the returns of the n top and bottom performers for your holding period (e.g. 1-mo)
- Estimate your historical returns and volatility and compare them to a benchmark – in this case S&P500 index. Is there persistence in the returns?