CASSIA TRADING
INVESTING MASTERY COURSE
Residual Momentum:
Capturing Pure Firm-Specific Returns
Idiosyncratic Momentum per Blitz, Huij, and Martens (2011)
Academic Citation
2011Blitz, D. C., Huij, J., & Martens, M. (2011). Residual Momentum. Journal of Empirical Finance, 18(3), 506-521.
Module Overview
Key Insights
What is Residual Momentum?
Core Definition
The Formula
Total Return Decomposition
The Problem with Total Momentum
Factor Contamination
US Markets Example: Tech Rally 2020-2021
Total vs Residual Momentum
| Aspect | Total Momentum | Residual Momentum |
|---|---|---|
| Signal Source | All returns (α + β) | Only residuals (ε) |
| Factor Exposure | High | Neutral |
| Beta to Market | ~1.2 | ~0.1 |
| Sharpe Ratio | 0.45 | 0.85 |
| Max Drawdown | -22% | -8% |
| Turnover | Medium | Similar |
| Implementation | Simple | Complex |
How Residual Momentum Works
Regression Methodology
Select Factor Model
Use Fama-French 3-factor or Carhart 4-factor model as baseline
Run Time-Series Regression
For each stock, regress 36 months of returns against factor returns
OLS(stock_returns ~ market + SMB + HML)
Extract Residuals
Save regression residuals (ε) for each month—this is the idiosyncratic return
Signal Construction
Calculate Cumulative Residuals
Sum residuals over past 12 months (skip most recent month to avoid reversal)
Rank and Portfolio Formation
Monthly Rebalance
Re-run regressions and update rankings monthly with rolling windows
Core Intuition
By removing factor exposures, we isolate pure firm-specific momentum—the part of returns driven by company fundamentals, earnings surprises, and investor attention, not broad market trends.
The Calculation Process
Step-by-step workflow with US markets example
Example: Apple Inc. (AAPL)
Data Required
Step 1: Run Regression
Step 2: Extract Residuals
Final Signal Calculation
Step 3: Sum Residuals
Skip month t-1 to avoid short-term reversal
Step 4: Ranking
Performance Comparison
Residual vs Total Momentum vs Market (1990-2010)
Residual Momentum
Total Momentum
Market Benchmark
Factor Decomposition
Breaking down return sources
Alpha Generation
Residual momentum generates +9.2% alpha vs total momentum's +2.1%
Factor Neutrality
Near-zero exposure to market (0.09), size (-0.02), value (0.01)
Risk Reduction
Volatility drops from 18.2% to 10.8%
Python Implementation
Complete code example with pandas and statsmodels
Residual Momentum Calculator
import pandas as pd
import numpy as np
from statsmodels.api import OLS, add_constant
def calculate_residual_momentum(stock_returns, factors,
lookback=36, signal_period=11):
data = pd.concat([stock_returns, factors], axis=1).dropna()
residuals = []
for i in range(lookback, len(data)):
window = data.iloc[i-lookback:i]
X = add_constant(window[['MKT', 'SMB', 'HML']])
y = window['stock_return']
model = OLS(y, X).fit()
current_resid = data.iloc[i]['stock_return'] - model.predict(
add_constant(data.iloc[i][['MKT','SMB','HML']])
)[0]
residuals.append(current_resid)
if len(residuals) >= signal_period:
resid_momentum = np.sum(residuals[-signal_period:-1])
else:
resid_momentum = np.nan
return resid_momentum
print("Residual Momentum Ready")Key Components
Required Data
Pro Tip
Use Kenneth French data sources for factor construction.
Excel Implementation
Practical worksheet approach with formulas
Worksheet Structure
Sheet 1: Raw Data
Sheet 2: Regression Output
Sheet 3: Residuals & Signal
Key Excel Formulas
=Intercept + (Beta_MKT*C37) + (Beta_SMB*D37) + (Beta_HML*E37)=B37 - F37=SUM(G37:G47)=LINEST(B13:B48, C13:E48, TRUE, TRUE)Excel Tips
Use Cases & Applications
Portfolio Construction
US Markets Example Strategy
Long top 20 stocks by residual momentum (e.g., Apple, Microsoft, JPMorgan), short bottom 20 (laggards), rebalance monthly. Target 10-15% annual alpha.
Risk Management
Stock Selection Filter
Practical Limitations
Key Takeaways & Next Steps
What You Learned
Next Steps
Further Reading
Module Complete!
You now understand how to construct factor-neutral momentum strategies that capture pure firm-specific alpha. Apply this to your US trading to identify genuine outperformers.