In Brief:
| Element | Benefit | Risk |
| Outperformance potential | Can beat market in trending environments | Lags in reversals, bear markets |
| Systematic approach | Rules-based, avoids emotional trading | High turnover, tax implications |
| Diversification | Uncorrelated with value/growth | May become sector-concentrated |
| Flexibility | Works in stocks, ETFs, other classes | Not infallible, subject to crowding |
Momentum investing is a widely studied and influential strategy in financial markets. The strategy is built on the principle that stocks that have performed well recently tend to continue outperforming in the near future, while recent laggards often keep underperforming. The concept can also be applied to market indices as well as other asset classes such as commodities, currencies, real estate, gold, crypto, and even collectibles.
The approach stands in contrast to value investing, where the goal is to buy stocks that are undervalued for some reason and sell them at their true value.
Momentum Trading vs. Value Investing
| Element | Benefit | Risk |
| Outperformance potential | Can beat market in trending environments | Lags in reversals, bear markets |
| Systematic approach | Rules-based, avoids emotional trading | High turnover, tax implications |
| Diversification | Uncorrelated with value/growth | May become sector-concentrated |
| Flexibility | Works in stocks, ETFs, other classes | Not infallible, subject to crowding |
It is most similar to growth investing in that it is looking not for inexpensive stocks but stocks that are trending higher. There is an important distinction between growth and momentum investing, however, and we will get to that in a moment
Momentum investing is a strategy that aims to capitalize on existing trends in asset prices. Momentum investors buy stocks showing an upward price trend (positive momentum), or if they are short sellers, they may short (sell) stocks with a downward trend (negative momentum).
“Buy winners, sell losers” may be the mantra of momentum investors. That sounds pretty obvious, like the idea of buying low and selling high, but is not as easy in real life because investors are people and are thus influenced by factors that aren’t always perfectly logical.
Rather than finding undervalued companies or predicting reversals, momentum investors ride current price trends until signs of reversal appear. The indicators that momentum traders rely on come from technical analysis of the market and the price performance of the stock.
Momentum traders frequently use technical analysis to identify stocks whose shorter-term (often 50-day average) price trends are trading above their longer-term (often 200-day average) trends as potential targets. When the shorter-term average reverses course and falls below the longer-term trendline, that signals it is time to sell.
Note: Where momentum traders rely on technical analysis to determine when to buy and sell, growth investors use both technical and fundamental analysis, which assesses financial performance and economic indicators.
Momentum’s effectiveness is well documented. The most influential evidence comes from a 1993 study that showed that U.S. stocks with high returns over the prior 3–12 months continued to outperform for the next 3–12 months.
The success of momentum trading flies in the face of the “efficient market theory,” which holds that investors have access to essentially the same information at the same time and then behave perfectly rationally, so it is therefore impossible to consistently beat the market.
Why does momentum trading work then?
The answer lies in human nature. Human beings are subject to a wide range of cognitive distortions or biases. In the case of momentum, traders are leveraging the human tendency to under-react to new information at first (anchoring), then over-react (herding), fueling price trends.
In addition, institutional or algorithmic trading can exacerbate momentum effects. And the reality is that even though, in most cases, all relevant information is publicly available, not all market participants act instantly on news, allowing trends to persist.
Momentum strategies can be implemented in different ways:
Single-Asset Momentum: Buy stocks with the best recent performance and sell (or avoid) those with the worst.
Sector/ETF Momentum: Rotate capital into the strongest performing sectors or ETFs (e.g., Tech, Health Care).
Relative Strength Strategies: Trade pairs or baskets by going long the strong and short the weak (often market-neutral).
Absolute Momentum: Invest only when an asset is positive over a set period (e.g., stocks are above their 200-day moving average).
Academic studies and many real-world funds show that momentum strategies usually beat the market in trending environments, with outperformance averaging 5–7% per year over long periods. Note that these strategies lag in sharp reversals and bear markets.
To clarify how this works, let’s look at an example. Let’s say you had screened the S&P 500 stocks for 12-month price momentum for each month, bought the top 10% performers and held them for 3 months. What would that have gotten you?
Using this hypothetical momentum strategy, here’s how it would have compared to the S&P 500 returns over the 10 years, from 2015 through 2024.
| Momentum vs. S&P 500 Returns | |||
| Year | Momentum Return | S&P 500 Return | Delta |
| 2015 | 14.80% | 10.10% | 4.70% |
| 2016 | 10.20% | 12.00% | -1.80% |
| 2017 | 21.70% | 18.00% | 3.70% |
| 2018 | -7.90% | -4.40% | -3.50% |
| 2019 | 29.40% | 31.50% | -2.10% |
| 2020 | 25.50% | 16.30% | 9.20% |
| 2021 | 18.80% | 26.90% | -8.10% |
| 2022 | -5.20% | -18.10% | 12.90% |
| 2023 | 17.40% | 24.90% | -7.50% |
| 2024 | 12.30% | 12.20% | 0.10% |
Over that 10-year period, momentum trading outperformed the S&P 500 by a total of 7.6 percentage points.
Benefits of Momentum Trading
1. Empirical Effectiveness: Persistently outperformed other styles over multiple decades and in almost all major markets.
2. Simple & Quantifiable: Clear rules make it suitable for systematic and algorithmic investing.
3. Low Correlation with Value & Growth: Adds diversification to a portfolio mostly composed of value or growth assets.
4. Adaptive and Flexible: Works across asset classes, geographies, and in rising or falling markets.
5. Exploits Behavioral Biases: Capitalizes on investor psychology and slow information incorporation.
Risks of Momentum Trading
1. Trend Reversals: Momentum strategies can suffer in periods when trends suddenly reverse—such as during market crashes or rapid recoveries. For example, in early 2020, many momentum portfolios had overweight positions in tech stocks and were hurt when the pandemic-induced selloff led to rapid shifts in sector performance.
2. High Portfolio Turnover and Costs: Rapid buying and selling generate higher trading costs and tax liabilities.
3. Crowding and Decay: If too many investors use momentum at once, crowded trades can quickly unwind.
4. Underperformance in Range-Bound Markets: In sideways or volatile markets without clear trends, momentum strategies may lag.
5. Whipsaw Risk: False signals caused by short-term volatility can lead to frequent losses.
6. Sector/Factor Rotation: Momentum strategies can become concentrated in single sectors during strong trends, increasing exposure to sector-specific risk.
5 Tips for Momentum Traders
1. Diversify Across Sectors and Styles: Don’t concentrate entirely on one segment or region—momentum can rotate among sectors.
2. Control Costs and Taxes: Use tax-efficient accounts and low-cost platforms to minimize turnover costs.
3. Use Robust Trend Filters: Extend holding periods or add risk filters (e.g., stop losses, volatility controls) to avoid whipsaws.
4. Monitor Crowding Risks: Watch for periods where momentum strategies become mainstream and may be at risk of reversal.
5. Combine with Other Factors: Momentum blends well with quality or low-volatility strategies for smoother performance.
Momentum investing can enhance portfolio returns and add strategic diversification but requires discipline and risk management. Momentum’s main appeal lies in its systematic nature, behavioral underpinning, and historic success. However, its vulnerability to sharp reversals, trading costs, and crowding must be managed with sound portfolio practices and robust analysis.
Momentum investing remains an enduring and influential strategy in modern portfolio management. By exploiting persistent trends and investor biases, it often delivers robust returns in trending markets.
However, its sharp underperformance during rapid reversals underscores the need for careful execution, diversification, and ongoing risk control. For investors willing to accept potential volatility and the need for active management, momentum can be a rewarding part of a broader investment strategy.
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