Momentum in Canadian Stock Returns

Abstract Empirical evidence suggests that U.S. and Canadian stock returns follow predictable patterns over a shortterm horizon. In particular abnormal profits could have been generated by purchasing previous strong performers and selling previous poor performers. Our evidence suggests that a portion of this profitability represents appropriate compensation for risk and risk premiums that vary through time. We also examine the impact of transactions costs on the implementation of this strategy and find it may not be exploitable by the average retail investor facing higher levels of transactions costs. However, sensitivity analysis indicates that momentum trading may have merit for more nimble traders facing lower transactions costs. Resume Les donnees empiriques suggerent que le rendement sur les actions aux ttats-Unis et au Canada se conforme, a court terme, a des modeles previsibles. En particulier des profits anormaux auraient pu etre generes par l'achat d'anciens performateurs forts et la vente d'anciens performateurs faibles. Nos donnees suggerent qu'une partie de cette rentabilite represente une compensation appropriee au risque et aux primes de risque qui varient avec le temps. Nous examinons aussi l'impact des frais de transaction sur la mise en pratique de cette strategie, et nous trouvons que l'investisseur individuel moyen contraint a faire face a des frais de transaction plus eleves ne serait peut-etre pas en mesure de l'exploiter. Cependant, l'analyse de susceptibilite indique que la strategie de placement par "momentum" aurait peut-etre de la valeur pour des investisseurs plus agiles confrontes a des frais de transaction moins eleves. There is extensive literature examining the performance of technical trading strategies, which attempt to identify and exploit recurring patterns in stock market return series through time. DeBondt and Thaler (1985) and subsequent studies provided evidence on the profitability of 3- to 5-year contrarian strategies, which involve buying past poor performers and selling past strong performers. Brock, Lakonishik, and LeBaron (1992) used 90 years of daily data (1897-1986) on the Dow-Jones Industrial Average to show that moving average and trading range break-out strategies produce superior returns. It is difficult to provide satisfactory justification for these strategies at an intuitive level. Malkiel (1981) went so far as to suggest that "technical analysis is anathema to the academic world. " (p. 116) Certainly, if we accept the general notion that security markets are efficient, then security prices at a given point in time should reflect the relevant information available at that time. Hence prices should change due to the arrival of new information, which by its very nature is unpredictable. Despite the apparent lack of theoretical foundation, we observe that most security analysts provide a substantial amount of technical information to support their recommendations. In this paper, we examine one such technical strategy that appears to generate abnormal returns according to recent empirical evidence. Several studies indicate that forming portfolios based on a price-momentum model by buying stocks that have performed well in the recent past and selling those that have performed poorly have outperformed the equity market as a whole. Jegadeesh and Titman (1993) examined New York and American stock exchange data over the past 3 decades using all available common stock returns on the Center for Research in Security Prices (CRSP) data file. Their momentum-based strategy generated significant excess returns, even after controlling for systematic risk. The existence of this pattern in U.S. stock returns is confirmed by Chan, Jegadeesh, and Lakonishok (1996) and by Karolyi and Kho (1996). Foerster, Prihar, and Schmitz (1994/1995) followed a similar strategy to Jegadeesh and Titman (1993) using Canadian data from 1978 to 1993 and documented even stronger evidence of momentum in stock returns. …