The Momentum Gap and Return Predictability

The formation period return difference between past winners and losers, which I call the momentum gap, negatively predicts momentum profits. I document this for the U.S. stock market and find consistent results across 21 major international markets. A one standard deviation increase in the momentum gap predicts a 1.25% decrease in the monthly momentum return after controlling for existing predictors. This predictability extends up to five years for static momentum portfolios, consistent with time-varying investor biases. Following the simple real-time strategy of investing in momentum only when the momentum gap is below the 80th percentile substantially increases its Sharpe ratio