The concept of the short term reversal seems at first to be contrary to that of momentum. However the time line considered is the key difference. Stock price momentum is a persistent signal over a period of time that excludes the most recent one or two months. For example, screening for momentum on December 31st, you might rank the total return over the period from January 1st of that same year up until the end of October or November (most recent twelve months minus the most recent one or two months). The reason the most recent month (at a minimum) is excluded, is that price action during this period is not a good signal to use for momentum. In fact, analyzing recent period price action tends to give the opposite signal, hence the concept of the short term reversal.
A positive momentum signal indicates the medium term is favorable for investing. The proverbial “trend is your friend”. Short term reversal can be used as a signal that perhaps prices may have moved too far, too fast in the recent one month time period.
The chart below measures the performance of the weakest performing stocks (bottom 20%) over the prior month and how the factor explains performance relative to the broad market. The inclusion of the reversal factor is one of the unique characteristics of the Atlas strategy. The factor has very strong historical performance, but also has very high transaction cost which reduces the real out-performance portfolios may experience.
To get a more detailed look at the data set please click the link. French Fama Data set