In this study, Narasim Jegadeesh and Sheridan Titman (1993) presented the existence of a momentum effect. They attribute this effect to the fact that investors underreact to the release of firm-specific information. In detail, they compared the performance of stocks that have performed well in the past with those that have performed poorly, in
3-12 months’ time.
Their theory is if stock prices either overreact or underreact to information consistently then profitable trading strategies that select stocks based on their past returns will exist.
Previous studies in this area had shown that over a 3 to 5 year horizon, stocks that had performed poorly over the previous 3 to 5 years achieved higher returns than stocks that performed well over the same period. Their study covered the period from 1965 to 1989, involved ranking each company at the beginning of each month by its returns over the last ‘J’ months.

Based on these rankings, ten equally weighted decile portfolios are constructed, with the portfolio comprised of those companies with the strongest historical returns and the portfolio with the lowest historical returns.

The timeframes for both ‘J’ and ‘K’ horizons were 3, 6, 9 and 12 months. They constructed portfolios based on companies’ 3 month historical returns, and looked at their performance over the subsequent 3, 6, 9 and 12 months.
The paper focused largely on the ‘zero cost’ portfolios, representing the difference in performance between the ‘winners’ and ‘losers’.
It is important to note that momentum strategy appears to be temporary in nature.
Over short time-frames of 3 to 12 months, past winners continues to perform strongly, and vice-versa. This pushes the price of these past winners (losers) above (below) fair value, which leads to lower (higher) medium to long term.
Performance of Relative Strength Portfolio Strategy
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Sub-period analysis o Seasonal Patterns
January (lowest)
August (low)
April, November and December (high) o 5-year Subperiods
In 1975-1979, the returns were negative due to the January performance of small firm; positive returns were observed on medium and large sized firms similarly, returns were positive when January is excluded

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Performance of the strategy in Event Time

With the exception of month 1, the average return in each month is positive in the first year. The average return is negative in each month in year 2 as well as in the first half of year 3. The negative returns after a year indicate that the relative strength strategy does not tend to pick stocks that have high unconditional expected returns
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Back-testing strategy

From 1941 to 1964: returns were negative due to the volatility in the market. Many firms declared bankruptcy.
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Stock Returns Around Earnings Announcement Dates

Stock returns for past winners realize positive returns around the time when their earnings are announced and it goes the same way for past losers – they realize negative returns around the time their earnings are announced.