Extreme absolute strength of stocks and performance of momentum strategies

Abstract

We find that removing stocks with extreme absolute strength from typical momentum portfolios can enhance their performance. Using data on common stocks traded on NYSE, AMEX, and NASDAQ, we find that stocks with extreme absolute strength feature very high volatility and are more likely to lose their momentum. Removing these stocks from typical momentum portfolios significantly reduces the volatility of the portfolios and increases the average return in most cases, improving the portfolios' performance. The removal of stocks with extreme absolute strength can also effectively alleviate the problem of momentum crashes and render momentum strategies profitable in the post-2000 era, a period during which momentum appears to have vanished.