Figure 1 illustrates the results, plotting the relationship between size and the magnitude of the momentum effect. As can be seen, there is a pronounced, inverted U-shape. In the very smallest stocks (which are tiny, with a mean market capitalization of $7 million) momentum is actually negative. By the second size decile, momentum profits are significantly positive, and they reach a peak in the third size decile, where market capitalization averages about $45 million and where the profits are a striking 1.43% per month (t-stat = 6.66), which is almost three times the value for the sample as a whole. After the third size decile, momentum profits decline monotonically, to the point where they are essentially zero in the largest stocks.
The non-monotonic effect of raw size can be easily understood in the context of the informal theory sketched in the Introduction: smaller firms may have slower information diffusion, which would lead to greater momentum, but they probably also have more limited investor participation (i.e., thinner market-making capacity) which can lead to more pronounced supply-shock-induced reversals. Under this interpretation, the sharp decline in momentum profits that occurs between the third and the tenth size classes is testament to the economic importance of gradual information diffusion in mid-cap stocks.
Another interesting pattern that emerges in Table 3 is that the bulk of the momentum effect seems to come from losers, as opposed to winners. Consider for example, the column corresponding to the third size class, where as we noted above, the P3-P1 winners-minus-losers measure is 1.43% per month. Of that, 1.05%, or about three-quarters of the total, comes from the difference between average performers and losers, i.e., from P2-P1. As can be seen from the table, this general tendency holds-with remarkable consistency-in every one of the size classes (i.e., deciles two through eight) where there are positive momentum profits to begin with. It suggests that to the extent that stock prices do underreact, they are more prone to underreact to bad news than to good news. We will return to this theme in greater detail below.