Momentum Investing — momentum strategy

What is momentum investing?

Momentum investing is an investment strategy based on the observation that assets that have been rising recently tend to continue rising — and those that have been falling often continue to fall. You buy "winners" and avoid "losers."

Quick Answer

Momentum investing is a trend-following strategy based on the observation that assets rising recently tend to keep rising, while falling ones often keep falling. Documented by Jegadeesh and Titman (1993), it buys companies with the highest returns over the past 3-12 months and sells the worst, rebalancing monthly or quarterly. It has historically beaten buy-and-hold across many markets but is exposed to momentum crashes at sharp trend reversals. This is general educational information, not investment advice.

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Where does the momentum effect come from?

Momentum is one of the best-documented factors in academic finance. Research by Jegadeesh and Titman (1993) showed that a strategy of buying companies with the highest returns over the past 3-12 months and selling the worst performers generates above-average returns.

Causes:

• Crowd psychology — investors react with delay to new information
• Herding effect — rising assets attract more buyers
• Fundamental confirmation — rising price often reflects improving company performance

How does momentum strategy work?

Simple version

1. Every month (or quarter) check which assets gave the highest returns in the last 6-12 months
2. Buy those from the top of the ranking
3. Sell those that dropped out of the top
4. Repeat

Momentum indicators

• Relative Strength (RS) — return over the last 12 months (excluding the last month)
• Moving Average — price above moving average (e.g., 200-day) → positive signal
• Rate of Change (ROC) — percentage price change over a given period

Advantages of momentum

• Historically higher returns than simple buy-and-hold (documented across many markets and asset classes)
• Works globally — not only in the US, but also in Europe, Asia, commodity markets
• Can protect against deep bear markets (exit signal when momentum reverses)

Disadvantages and risks

• Momentum crash — at the moment of trend reversal (e.g., V-recovery after a crash) the strategy can suffer large losses
• High turnover — frequent transactions generate commissions and taxes
• Psychological difficulty — buying at peaks and selling falling assets goes against human intuition
• Delayed signals — momentum reacts with delay to sudden changes

Momentum vs other strategies

Momentum perfectly complements value investing. Historically, the correlation between these strategies is low or negative — when one doesn't work, the other often compensates. A portfolio combining both factors (value + momentum) gives more stable results.

Momentum ETFs

• iShares Edge MSCI World Momentum Factor — global companies with strong momentum
• iShares MSCI USA Momentum Factor — US momentum companies
• Xtrackers MSCI World Momentum — European alternative

How Freenance can help

Freenance analyzes your portfolio dynamics and shows which positions have strong momentum and which are losing steam. This helps make informed decisions about rebalancing and allocating new funds.

👉 Monitor portfolio momentum with Freenance — freenance.io

FAQ

What is the 12-1 month momentum signal?

The 12-1 month signal ranks assets by their total return over the past 12 months while excluding the most recent month. The skip helps avoid short-term reversal effects that academic research shows can hurt pure 12-month rankings. This formulation, popularised by Jegadeesh and Titman, is one of the most widely cited momentum measures in finance.

Why does momentum work in markets?

Academic explanations include behavioural under-reaction to new information, gradual herding by other investors, and the reinforcement of trends by improving fundamentals. None of these explanations is universally accepted, and momentum can fail unpredictably. As with any factor, past performance does not guarantee future results.

Is momentum investing the same as day trading?

No — classic momentum investing operates on a horizon of several months to a year, not minutes or hours. It involves periodic (monthly or quarterly) rebalancing rather than constant intraday activity. Day trading typically relies on much shorter price patterns and far higher leverage and turnover.

What is a "momentum crash"?

A momentum crash occurs when sharp market reversals — often after panics or recessions — cause previously losing assets to rebound rapidly while previous winners lag. Because a momentum strategy is long winners and short losers (or simply heavy on winners), it can suffer outsized losses during these turning points. Research has documented several such crashes historically.

How does momentum compare with value investing?

Momentum and value have historically shown low or negative correlation, which is why some long-term investors combine them. When growth-led momentum is leading, value often underperforms — and vice versa. Combining factors does not eliminate risk; it just diversifies the sources of return. This is general educational information, not investment advice.

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• Value Investing — inwestowanie w wartość
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