Are Momentum Profits Robust to Trading Costs?

TLDR

The study tests whether momentum strategies remain profitable when accounting for trading frictions. Using intraday data, the authors estimate proportional and price‑impact trading costs, compute break‑even fund sizes, and develop a liquidity‑weighted momentum strategy to reduce trade costs. Abnormal returns fall as portfolio size grows; equal‑weighted momentum performs best before costs but worst after, while liquidity‑weighted and hybrid strategies require at least $5 B to break even before profits disappear.

Abstract

ABSTRACT We test whether momentum strategies remain profitable after considering market frictions induced by trading. Intraday data are used to estimate alternative measures of proportional and non‐proportional (price impact) trading costs. The price impact models imply that abnormal returns to portfolio strategies decline with portfolio size. We calculate break‐even fund sizes that lead to zero abnormal returns. In addition to equal‐ and value‐weighted momentum strategies, we derive a liquidity‐weighted strategy designed to reduce the cost of trades. Equal‐weighted strategies perform the best before trading costs and the worst after trading costs. Liquidity‐weighted and hybrid liquidity/value‐weighted strategies have the largest break‐even fund sizes: $5 billion or more (relative to December 1999 market capitalization) may be invested in these momentum strategies before the apparent profit opportunities vanish.