Transaction Costs, Trading Volume and Momentum Strategies

Abstract

This article considers the relationship between trading volumes, transaction costs, and the profitability of momentum strategies using data from the U.K. The authors demonstrate that round-trip transactions costs for selling loser firms are about double those for buying winners, and in particular, the costs of selling low-volume losers is more than twice that for selling low-volume winners. By contrast, there are only modest differences between the costs of buying winners and losers, irrespective of their volume levels. Yet the authors observe that, even in net terms, momentum strategies based on low-volume stocks are more profitable than those using high-volume stocks. It is also noted that important differences between transaction costs are measured using quoted versus effective spreads. Altogether, the findings should sound a word of caution for any study attempting to evaluate the impact of transaction costs on momentum profitability, that such costs are very heterogeneous across firms and trade types, implying that they require careful calculation.