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Momentum and rotation
Why does cross-sectional momentum need a basket?
Cross-sectional momentum
What it bets
Names that were relatively stronger over the past several months stay stronger, for the next stretch, than the names that were relatively weaker.
How the rule is written
Rank one basket by its return over a past formation period. Go long the names at the top of the rank and short the names at the bottom, or hold only the leading group. The 1993 stock study by Jegadeesh and Titman uses a formation period of several months. Watching one market rise or fall, with no cross-section, is not this method.
When it fails
In a reversal month the ranks change sides together. If the formation period is changed to one week, published research more often finds reversal, not momentum.
Do not confuse it with
Time-series momentum does not rank. Relative-strength rotation is usually long only, and it changes holdings on a calendar. Cross-sectional momentum can hold a long side and a short side at the same time.